AYB227 Semester 1 2019: Foreign Currency and Hedging Analysis Report

This report delves into the critical aspects of international accounting, specifically focusing on foreign currency transactions and hedging techniques. It explores foreign exchange rates, risks, and the mechanisms used to mitigate these risks, including forward contracts, futures, and options. The report examines operational hedging strategies, highlighting their significance in managing market-related risks, such as those faced by global companies like Coca-Cola. It also outlines the application of derivative financial instruments to reduce exposure and the importance of objective measurement systems and hedging tools used for up to thirty-six months. The assignment is based on the AYB227 course and includes an overview of foreign exchange rates, the impact of rate fluctuations, and the accounting practices associated with foreign currency transactions, cash flow hedges, fair value hedges, and hedge accounting.

INTERNATIONAL ACCOUNTING

Forward Contract
Forwar
d
Contra
ct
Advantages Disadvantages
1. The main advantage of forward
exchange contracts is that they
fix the future rate. In this way,
the downside risk exposure can
be eliminated.
The forward
exchange contracts
are subject to
default risks.
2. The other advantage of forward
exchange contracts is that it
ensures the flexibility in relation
to the amount to be covered.
These contracts can
be difficult to cancel
(Kuzmina &
Kuznetsova, 2018).
3. The forward contracts are
relatively straight forward to
understand.
In the forward
exchange contracts,
it can be difficult to
search the counter
party.

Forwar
d
Contra
ct
Advantages Disadvantages
4. These contracts are very simple to
organize.
These contracts need
tying up capital.
5. These contracts offer the complete
hedge. There are no
opportunities to benefits
from favorable
movement in the
exchange rates.
6. They are tailor made. These contracts
may be written for any period and for
any amount.
The main disadvantage is
that the contractual
commitments are
required to be completed
when it become payable
(in case of uncertainty,
option date forward
contract can be used).

Forward
contract
Advantages Disadvantages
7. It may be matched against
period of exposure and for a
cash size of the exposure.
The other disadvantage
of this contract is
availability.
8. They are over the counter
products.
There is no intermediate
cash flow prior to
settlement.

Futures
Futur
es
Advantages Disadvantages
1. The main advantage of currency futures
contracts is low margin.
The main disadvantage of
currency futures
contracts is that losses
may exceed the account
balance at any time.
2. The other advantage of currency futures
contracts is high liquidity.
It sets amount traded in
lot.
3. The costs of these contracts are very low. There are certain brokers
who don’t permit the
deliveries.
4. It is probable to profits without taking
deliveries.
It is limited to specialized
traders (Seksan &
Amaruchkul, 2018).
5. Further, the pricing of these contracts are
easy to understand.
The currency futures
contracts are majorly
based on paper.

Options
Optio
ns
Advantages Disadvantages
1. The currency options are inexpensive for
trading.
The main disadvantage of
currency options is that
they rapidly become
worthless.
2. These are available on or off exchange. The currency options can
be illiquid.
3. In currency, there are various approaches
to consider over volatility and the
movement of price.
These are very
complicated to
understand (Hoberg &
Moon, 2017).
4. In case when one is buyer, then risks are
limited only to premium.
In case when one is seller,
then risks are unlimited.
5. There are very high potential returns vs.
risks
They do not have much
volume.

Operational Hedging
In a finance literature, the operational hedge is very
significant to understand.
The operational hedging refers to the action’s course,
which hedges the risk exposures of company by the
resources of non-financial tools, specifically by the
operational functions.
The people cannot attain the prices they desire,
however they must get or get rid of the items.

In this way, the operational hedging means that the a
person get to purchase even though the items are in the
shorter delivery, or to put up for sale even though the
items are in over supply.
The hedging is the almost wholly the financial
operations, since it means that after the people placed
the huge bet, they buy certain types of instruments such
as option, which would pay off if the big bets go against
them.
This decreases the risks of losses (Chen, Ewald & Kutan,
2019).

Further, Coca Cola, as the global company, is
discovered to various risks related to market like
the operation in the foreign exchange rates and
price of commodities that can influence the
company particularly in financial performances.
In this way, the firm frequently exercises
certain derivative financial instruments mostly to
reduce the exposure and decrease the risks of
market through the hedging a fundamental
financial exposure (Lence, 2016).

On the other hand, an organization Does not
accept the derivative products or the objectives of
trading.
In the addition, the tools related to hedging are
normally utilized up to thirty six months in an
advance.
Further, it would expire in thirty six months or less
than thirty six months.

The exposure to the financial market risks then
would be reviewed using various objective
measurement systems like the sensitivity evaluation.
 It also undertakes collars to hedge the particular
part of projected cash flow that also denominated in
other currency.

References
Chen, J., Ewald, C., & Kutan, A. M. (2019). Time-
dependent volatility in futures contract
options. Investment Analysts Journal, 48(1), 30-41.
Hoberg, G., & Moon, S. K. (2017). Offshore
activities and financial vs operational hedging. Journal
of Financial Economics, 125(2), 217-244.
Kuzmina, O., & Kuznetsova, O. (2018). Operational
and financial hedging: Evidence from export and
import behavior. Journal of Corporate Finance, 48,
109-121.

Lence, S. H. (2016). MODELING THEMARKET
ANDWELFARE EFFECTS OFMEXICO'S" AGRICULTURE
BY CONTRACT" PROGRAM. American Journal of
Agricultural Economics, 98(3).
Seksan, J., & Amaruchkul, K. (2018). Return Policy
and Buyback Contract in Closed-Loop Supply
Chain. Advanced Science Letters, 24(11), 8165-8170.