Misconceptions About Hedging (continued) – This post is a continuation of a previous series of posts on the various misconceptions about hedging. Over the next several BLOG posts I will raise a particular misconception about hedging and provide an alternative viewpoint. If you have an agreeable or a counter viewpoint, then feel free to respond either on the post or email me directly at DStowe@StrategicTreasurer.com .
Misconception about hedging #4: It’s Important for My Hedges to Make Money.
This premise misses the point in hedging (see Strategic Treasurer’s Treasury Update Volume 4, Fall 2008/Spring 2009). While no prudent financial manager consciously makes a decision to lose money, the objective in hedging is more about providing predictability to cash flows or the ability for management to plan, which are two key factors, among others, which contribute to hedging’s impact on a firm’s value. It is not about making money or beating the market, per se, that matters, although many hedges are put in place opportunistically, i.e. to lock-in or secure an attractive level in a commodity or rate – this, of course, is based on one’s perception of the future, which is situational of course. In the end, it’s the net exposure, or the combined value of the exposure, whether interest rate, foreign exchange or commodity price level, combined with the hedge position (level) that matters. The point is, you shouldn’t cheer for your hedges to make money, per se. The primary performance metric to consider is whether you, as risk manager, met your hedge objective, and NOT whether your hedge made money. Too often, the fear of losing money on a hedge is an unfortunate reason for not hedging, which really falls into the realm of speculation. If that is a primary concern, or a risk in itself, i.e. you lock in a level that would put your firm at a competitive disadvantage, then there are other alternatives, including hedging less (this still has to satisfy your firm’s risk constraints) or utilizing options, which give you the right, but not the obligation to lock-in future prices. DWS