Limited Foreign Exchange Exposure Through Hedging Research Paper

Limited Foreign Exchange Exposure Through Hedging - Research Paper Example The research paper discusses different kinds of hedging instruments employed by firms all over the world. The risk of the exchange rate is raised from the assets and liabilities or transactions dominated in foreign currencies or existing. The hedging activities of all firms are not alike and they may vary based on the core business of firms and kinds of their foreign exchange risk. The paper described the kinds of Hedging instruments including Natural Hedging and Foreign Exchange Derivatives. In order to evaluate hedging practices in Australia, data of up to March 2005 has been used apart from hedging surveys for Australia. The previous surveys show that the banking sector of Australia has always been well-protected from currency fluctuations. In the period following the floating of the Australian dollar, Australian banks had very little exposure to exchange rate risk because of the restrictions of regulations on international transactions. After the removal of these restrictions, banks have been financing their domestic assets through short term liabilities abroad. In order to limit their net exposures, the banks used to match foreign currency liabilities to their assets. For further eliminating the residual risk exposure, Australian banks have been using derivatives. The current market risk guidelines ask the Australian authorized deposit-taking banks to dete rmine their foreign currency exposure daily. The evaluation of adaptations of non-financial firms to exchange rate fluctuations show that these firms have been facing difficulties because of poor or little experience. In 1986, borrowers made 3000 foreign currency loans dominated in Swiss francs and they incurred huge losses when Swiss francs appreciated by 50% against the Australian dollar.