Managing FX Risk - a Value Maximizing Approach

Financial Management, Vol. 28, No. 3, pp. 68-75, Autumn 1999

8 Pages Posted: 7 Sep 2001

See all articles by Thomas E. Copeland

Thomas E. Copeland

University of San Diego - School of Business Administration

Maggie Copeland

Salomon Smith Barney/TIMCO

Abstract

Minimizing the probability of business disruption is presented as an objective for FX hedging programs. Within this context firms hedge when the benefits, defined as the reduction in the expected costs of business disruption, exceed the expected costs. This policy is value maximizing for the firm. Minimization of the variance of hedged operating cash flows, the usual approach, is an insufficient condition for minimizing the probability of business disruption within a predetermined period of time. In addition to the variance of hedged cash flows, two additional variables are important: 1) the ratio of operating cash inflows to cash outflows that represent the business disruption boundary - a coverage ratio, and 2) the reduction in the drift in operating cash flows caused by FX hedging costs. These are found to be important in the empirical literature that examines motivations for hedging.

Suggested Citation

Copeland, Thomas E. and Copeland, Maggie, Managing FX Risk - a Value Maximizing Approach. Financial Management, Vol. 28, No. 3, pp. 68-75, Autumn 1999, Available at SSRN: https://ssrn.com/abstract=267700

Thomas E. Copeland (Contact Author)

University of San Diego - School of Business Administration ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States

Maggie Copeland

Salomon Smith Barney/TIMCO ( email )

New York, NY 10013
United States

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