Index Investing News
Sunday, May 25, 2025
No Result
View All Result
  • Login
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion
No Result
View All Result
Index Investing News
No Result
View All Result

Rethinking Corporate FX Hedging: Seeing the Forest through the Trees

by Index Investing News
September 11, 2023
in Investing
Reading Time: 6 mins read
A A
0
Home Investing
Share on FacebookShare on Twitter


“It often happens that a player carries out a deep and complicated calculation, but fails to spot something elementary right at the first move.” — Alexander Kotov, Chess Grandmaster

Introduction

The FX impact on corporate earnings and guidance should be front of mind for both corporates and the analyst community. Indeed, more than 45% of revenues in S&P 500 companies originate internationally. But last year, the hedging performance of many US multinational corporations (MNCs) was well off the mark, and few CFOs explained their hedging decisions on earnings calls.

Why such poor hedging performance? After all, treasury management system (TMS) providers claim to offer “push-button” capabilities for limiting the FX impact within $0.01 of earnings per share (EPS). The answer may not be as elusive as some of us may imagine. Though hedging earnings has its challenges, including exposure estimation and accounting-driven issues, very few corporates actually hedge earnings risk to the consolidated income.

Around 60% of companies cite earnings volatility mitigation as a key risk management objective, but less than 15% actually hedge their earnings translation exposure, according to a Citibank survey. This raises an intriguing behavioral finance question: Could the varied financial accounting treatments of hedging transaction risk at the subsidiary level and translation risk at the consolidated income level be unduly influencing prudent decision making, resulting in a transference of financial accounting to mental accounting?

Key questions to consider include: Are CFOs and corporate treasurers making effective hedging decisions? Are they substituting expediency for substance, making decisions based on financial accounting considerations? Is there too much career risk in putting on fair value hedges?

On a broader level, how beneficial is it to categorize FX risk? Is it counterproductive to pigeon-hole FX exposures in neat boxes — transactional, translational, or structural?

The Fungibility of FX: One Risk, Three Forms

FX’s fungibility is easy to underestimate. For example, to better match client revenue to production costs, EU-based firms can reduce their structural risk by relocating production facilities to the United States. But they will just be substituting one core risk for another: transactional for translational.

Moreover, if a subsidiary reinvests its earnings instead of upstreaming dividends to its parent, then the unrealized transactional risk over the corresponding will accumulate to match the translational risk to the consolidated income. The difference between transactional and translational risks is not fundamental but an issue of timing.

Data Science Certificate Tile

Hedging vs. Accounting

Accounting rules provide for three types of hedges: fair value, cash flow, and net investment hedges. Fair value hedges result in the recognition of derivatives gains or losses in the current-period income statement. With cash flow and net investment hedges, current-period derivatives gains or losses are deferred through other comprehensive income (OCI), which is recorded on the shareholders’ equity section of the balance sheet.

Under IFRS, intercompany dividends can only be transactionally hedged once they are declared. This provides protection for the period between the declaration and payment, which is usually too short to significantly reduce the risk. If corporates are more inclined to execute cash flow hedges rather than fair value hedges — which can cover longer periods under an estimated exposure but must be dragged through the income statement — then adverse FX impacts should not come as a surprise whenever macro conditions deteriorate or during bouts of rapid USD appreciation. 

There are accounting hacks: One way corporates address unfavorable accounting treatment around earnings hedges is to classify them as net investment hedges whenever possible, since they have similar recognition mechanics as cash flow hedges. Through holding companies or regional treasury centers, some MNCs deploy such accounting-friendly solutions to manage genuine timing issues, which can also potentially incorporate economic and structural hedges.

Despite such methods, the broader questions remain: Why are publicly traded companies “routinely” blindsided by FX volatility? Do financial accounting rules influence hedging decisions? Do corporate treasurers and CFOs tend to avoid fair value hedges and, in the process, overlook earnings exposures? Is the tail wagging the dog? While the topic may receive limited attention in academia, sell-side practitioners catering to corporates know that accounting considerations often have an outsized influence on the types of “accounting exposures” that are hedged.

Tile for Gen Z and Investing: Social Media, Crypto, FOMO, and Family report

Boardroom Dynamics: Holding the CFO Accountable

Boardrooms need to do a better job of holding CFOs accountable. All too frequently, discussions regarding FX’s impact on EPS tend to trade the prosaic for the poetic. No asset class is better than FX for rhapsodizing on all things macro — from fundamentals, flows, institutional credibility, to geopolitical dynamics — but the elemental questions underlying the rationale for what is being hedged (or not hedged) are seldom, if ever, posed.

Similarly, debates on technology can become a canard that distracts from the underlying issues. While firms need systems that “talk to each other” and provide gross and net exposures across the company, flawless visibility is not a panacea in and of itself. As Laurie Anderson put it, “If you think technology will solve your problems, you don’t understand technology — and you don’t understand your problems.”

Smart hedging policies address a firm’s level of risk aversion relative to its market risks. A firm’s choice of risk measures and benchmarks is intricately linked to its specific circumstances: shareholder preferences, corporate objectives, business model, financial standing, and peer group analysis. “Know thyself” is a useful precept in this regard. For instance, if an MNC in the fast-moving consumer goods (FMCG) industry wants to maximize earnings while preserving its investment grade rating, then consolidated earnings-at-risk (EaR) ought to be among the appropriate risk-based measures. It’s essential that the right risk measures and benchmarks are pursued, regardless of accounting considerations.

Graphic for Handbook of AI and Big data Applications in Investments

Conclusion

To summarize, effective corporate hedging begins with understanding FX’s fungibility: Risk cannot be “categorized” away. Furthermore, there is no substitute for thoughtful hedging policies and selecting performance indicators that define success and ensure consistent interpretation and pricing of risk across the firm. These policies must also address the tension between the core hedging objectives and financial accounting considerations.

If you liked this post, don’t forget to subscribe to Enterprising Investor.


All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / FanPro


Professional Learning for CFA Institute Members

CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker.



Source link

Tags: corporateforestHedgingReThinkingtrees
ShareTweetShareShare
Previous Post

‘Aquaman And The Lost Kingdom’ Teaser Trailer – Deadline

Next Post

Aaron Rodgers’s Favorite Receiver Is Also the Jets’ Messenger

Related Posts

Learn how to Maintain Tariffs from Derailing Your Renovations (Rookie Reply)

Learn how to Maintain Tariffs from Derailing Your Renovations (Rookie Reply)

by Index Investing News
May 23, 2025
0

The financial panorama is shifting quick. With tariffs driving up materials prices, does the BRRRR (purchase, rehab, hire, refinance, repeat)...

If No One Follows the 4% Rule, What IS the Proper Withdrawal Price?

If No One Follows the 4% Rule, What IS the Proper Withdrawal Price?

by Index Investing News
May 23, 2025
0

Most individuals assume the “protected withdrawal charge” for retirement (or early retirement) is 4%. However, if that’s the case, why...

98% of Housing Markets “Weaker” Than Final 12 months: Good Information for Traders?

98% of Housing Markets “Weaker” Than Final 12 months: Good Information for Traders?

by Index Investing News
May 22, 2025
0

The Downgrade Is Achieved. The Investor Response Is Simply Starting

The Downgrade Is Achieved. The Investor Response Is Simply Starting

by Index Investing News
May 22, 2025
0

For world traders and institutional asset managers, Moody’s downgrade of US sovereign debt is greater than a symbolic sign —...

No 401(okay)? No Downside—Sensible Retirement Methods for the Self-Employed

No 401(okay)? No Downside—Sensible Retirement Methods for the Self-Employed

by Index Investing News
May 22, 2025
0

Next Post
Aaron Rodgers’s Favorite Receiver Is Also the Jets’ Messenger

Aaron Rodgers’s Favorite Receiver Is Also the Jets’ Messenger

Why the G20’s Ukraine compromise might not be all bad for Europe

Why the G20’s Ukraine compromise might not be all bad for Europe

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

RECOMMENDED

Washington State Approves Invoice Supporting Blockchain Adoption

Washington State Approves Invoice Supporting Blockchain Adoption

March 31, 2022
South Africa vs England: Lauren Filer hopeful of ODI sequence victory however is not going to underestimate hosts | Cricket Information

South Africa vs England: Lauren Filer hopeful of ODI sequence victory however is not going to underestimate hosts | Cricket Information

December 10, 2024
GM Looks to Parlay Battery Work Into New Energy Business : stocks

GM Looks to Parlay Battery Work Into New Energy Business : stocks

October 12, 2022
Solana DeFi project Friktion shuts down its user platform By Cointelegraph

Solana DeFi project Friktion shuts down its user platform By Cointelegraph

January 28, 2023
Vir Biotechnology, Inc. (VIR) Q1 2025 Earnings Name Transcript

Vir Biotechnology, Inc. (VIR) Q1 2025 Earnings Name Transcript

May 8, 2025
Saudi Arabia stocks lower at close of trade; Tadawul All Share down 0.24% By Investing.com

Saudi Arabia stocks lower at close of trade; Tadawul All Share down 0.24% By Investing.com

February 25, 2024
Delta Corp net profit plunges 59% amid GST woes and market decline By Investing.com

Delta Corp net profit plunges 59% amid GST woes and market decline By Investing.com

January 10, 2024
Vishwakarma scheme: Catalyzing entrepreneurship key to sustainable success

Vishwakarma scheme: Catalyzing entrepreneurship key to sustainable success

August 30, 2023
Index Investing News

Get the latest news and follow the coverage of Investing, World News, Stocks, Market Analysis, Business & Financial News, and more from the top trusted sources.

  • 1717575246.7
  • Browse the latest news about investing and more
  • Contact us
  • Cookie Privacy Policy
  • Disclaimer
  • DMCA
  • Privacy Policy
  • Terms and Conditions
  • xtw18387b488

Copyright © 2022 - Index Investing News.
Index Investing News is not responsible for the content of external sites.

No Result
View All Result
  • Home
  • World
  • Investing
  • Financial
  • Economy
  • Markets
  • Stocks
  • Crypto
  • Property
  • Sport
  • Entertainment
  • Opinion

Copyright © 2022 - Index Investing News.
Index Investing News is not responsible for the content of external sites.

Welcome Back!

Login to your account below

Forgotten Password?

Retrieve your password

Please enter your username or email address to reset your password.

Log In