Answer the question Essay Example | Topics and Well Written Essays - 500 words - 6

Answer the question - Essay Example This might lead to a loss for the firm (Ederington, 1979). In the following table, the expected values are calculated if the dollar values weaken. As per the calculations shown above, it can be seen that when the value of dollars weaken, the expected returns are lower. As a result the firm ends up obtaining lower return in Sterling. Hence it can be seen that the returns available in each of month of March, June and September would be low considering the futures market prices in each of these months. In order to prevent such a situation it is essential that the company undertakes hedging strategy (Stulz, 1984). Under the hedging technique, it becomes possible to conduct the sales at the current spot price, even at the future date. As a result loss due to weakening of dollar values can be prevented. In the above table it can be seen that if the firm sells at the spot price, set as per hedging, the expected realisable values are higher than the expected realisable values as per future rates. Hence hedging can be stated to be a suitable strategy when the dollar values actually weaken (Nance, Smith and Smithson, 1993). Hedging is essentially not required. If the dollar values become stronger, that is when lower proportion of dollars are required to be paid against each dollars. In the above table it can be seen that when the firm future market prices are lower than the spot prices, the expected values are higher (Allayannis and Ofek, 2001). As a result the firm earns a profit without undertaking the hedging technique. Therefore the hedging technique must not be undertaken when the future values of contracts are expected to be lower than the spot exchange rates. Hence it is important to understand what the future contract prices would be in comparison with the sport prices and accordingly determine whether to undertaken hedging techniques or not. When the