Background

One of the primary practical uses of derivatives in the market is the use by multinational corporate to hedge against risk based on the operations, investments, and financing activities. For corporations to engage in financial hedging there are a number of items that must be in place in terms of the development of a policy, the strategy development and finally, developing a process that will be used on an ongoing basis to implement hedging and monitor progress.

You have just been hired as the Treasurer of a major multinational manufacturing company that has operations and sales in over 10 countries. The nature of the business has resulted in revenues generated in a number of currencies, supplies purchased globally in many currencies, and a capital structure which includes financing attained (via bonds and bank loans) in a number of different countries across the globe. The primary reason that you were hired is that the incumbent Treasurer did not put a risk management process in place which has resulted in some rather large income statement hits over the past few years.

Question

• Which derivatives should we consider as part of our hedging approach? Which should be excluded and why?