[The Motives for Corporate Hedging among USA multinationals]

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Acknowledgement

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Abstract

In this study we try to explore the concept of “hedging” in a holistic context. The main focus of the research is on “corporate hedging” and its relation with “US multinationals”. The research also analyzes many aspects of “risk management” and tries to gauge its effect on “hedging”. Finally the research describes various factors which are responsible for “hedging” and tries to describe the overall effect of “corporate hedging” on “US multinationals”.

Table of Contents

CHAPTER 1: INTRODUCTION1

Background of the Study1

Hedging and Risk Management2

Research Aims and Objectives3

Significance of the study3

Ethical Consideration4

CHAPTER 2: LITERATURE REVIEW6

Hedging6

Hedging is a business management system7

Hedging as a risk management tool7

Hedging as a tool of financial management7

Multinational company8

Operations9

Multinational Companies in the USA9

Role of US multinationals in the world economy10

Financial Distress12

Taxation14

Uncertainty15

Hedging Options19

An example of hedging a put option (Put)19

Why Would a Bank Hedge Accounting?21

What are hedging instruments and items?22

What is the externalization?23

How to evaluate the effectiveness of hedging24

Example 125

Example of option hedging strategy call (Call)28

Commodity hedging28

Examples of hedging used in practice30

Foreign Investment Risk and Political Coverage32

Political Risk Insurance34

Trade-related insurance35

Employee Compensation37

Bonuses and gratuities37

Under Investment Problems38

Problems of Hedging and their Solutions40

Solution41

Coverage with Derivatives42

CHAPTER 3: METHODOLOGY46

Qualitative Research46

Research Design46

Literature Selection Criteria46

Search Technique46

Keywords Used47

CHAPTER 4: FINDINGS AND ANALYSIS48

CHAPTER 5: CONCLUSION54

REFERENCES56

BIBLIOGRAPHY59

Chapter 1: Introduction

Background of the Study

In a perfect world assuming no information asymmetries, taxes or transaction costs, there would almost be no justification for corporations to engage in hedging. Shareholders could hedge against risk exposures on their own at the same costs. However, in practice, many corporations adopt at least some financial engineering instruments to control their exposures to interest rates, foreign exchange rates, and commodity prices (Solnik, 1992, pp 431). The discrepancy between theories and corporate practice poses one crucial question: why firms manage risks? Managerial risk aversion could provide a rationale for corporate risk management. This hypothesis, based on agency theory, conjectures that the hedging demand is induced by managerial risk aversion. Managers typically have a significant amount of their wealth invested in the firm they manage. (Kaplanis, 1997, pp 765) Salary, bonus, and stock options are all tied to the performance of the firm. Risk-averse managers know that they will suffer from adverse consequences of operations in their companies, so they will direct their firms to engage in risk management if they find that the cost of hedging on their own account is higher than the cost of hedging at the corporate level. This theory predicts that the nature of executive compensation plan can influence a firm's risk management activities. Following this line of research, in this paper we examine ...