hedging question (1 Viewer)

[poptarts12345]

In the textbook it says that one method of establishing a natural hedge can be achieved by "arranging for import payments and export receipts denominated in the same foreign currency; hence any losses from a movement in the exchange rate will be offset by gains from the other. " However, I am a bit confused can someone explain how arranging payments and receipts denominated in the same currency such as USD minimise the currency fluctuation risk for an Australian business?

 

[jimmysmith560]

If there is a currency fluctuation that does not go in the favour of the Australian business (which in this case would be a depreciation of the Australian dollar), the Australian business could be at risk, provided it is using the AUD to complete a transaction/multiple transactions between itself and the foreign business. In such a case, the Australian business would have to pay more AUD to retain its ability to purchase the same goods/services from the foreign business, causing losses due to the depreciation of the AUD. In such a case, an Australian business can instead choose to deal with its foreign counterpart using a currency that is less prone to fluctuations, i.e. a more stable currency, the USD being a good example of such a currency, in order to address the issue (which implies negating any potential risk resulting from currency fluctuations by replacing the "dodgy" currency with a more stable one).

I hope this helps!