AbstractThis study investigates the foreign exchange risk management program of HDG Inc. (pseudonym), a US-based manufacturer of durable equipment. Precise examination of factors affecting why and how the firm manages its foreign exchange exposure are explored through the use of internal firm documents, discussions with managers, and data on3,110 foreign-exchange derivative transactions. Informational asymmetries, facilitation of internal contracting, and competitive pricing concerns appear to motivate why the firm hedges. How HDG hedges depends on accounting treatment, derivative market liquidity, exchange rate volatility, exposure volatility, and recent hedging outcomes.
Article Outline1. Introduction2. HDG and risk management operations 2.1. The structure of foreign exchange risk management2.2. The practice of foreign exchange risk management3. Motivations for foreign exchange risk management 3.1. Hedging or speculating?3.2. Traditional motivations3.3. Earnings smoothing3.4. Competitive impacts3.5. Facilitation of internal contracting4. The structure of derivative portfolios 4.1. Characteristics of hedge portfolios4.2. Determinants of hedging strategies5. Financial risk and firm value 5.1. Risk management and stock returns5.2. Future research6. ConclusionsAppendix A. Currency-specific hedged and unhedged exposuresAppendix B. Hedge ratio methodology and currency-specific resultsReferences