Not hedging is a decision for corporates

If we choose to do something out of our routine, it feels like an active decision. If I order a burger, at a burger joint, I’ve made that choice actively to go there and place that order. If instead, I’m at home, and eat a cheese sandwich, it’s still a decision. I’ve made a decision not to go to a burger joint and instead make something to eat at home. Clearly choosing to stay at home is somewhat easier than choosing to go out, but it’s still a decision nonetheless.


It’s the same in financial markets. If we make a decision to trade then that is seen as an active decision. But then so is the decision not to trade at any particular time. Let’s take the example of large corporates. They will face many different sorts of risk. Some of these risks can’t be hedged (and probably shouldn’t be hedged). However, there are some risks that can be hedged within financial markets, and where it might be appropriate to hedge.


If a corporate is operating across borders, it will often face FX risk. Choosing to hedge their FX risk is an active decision, and could reduce the risk they face. Not doing any hedging at all, is also a decision in itself, and can expose them to more FX risk. However, this isn’t the only financial risk that can be hedged. Let’s take an airline, as well as FX risks that they face, they also face considerable risk related to fact that kerosene is a huge expense for their business. They have the choice of hedging this risk against increases in crude oil. They will also likely face risk associated with interest rate changes.


Then there’s the question of how they should hedge these risks.  Say in FX, we could hedge fully (100%), not at all (0%), or have an active hedge that adjusts in a range between the two figures. Say we’re a US corporate and we have EUR accumulating in our European operation. We could hedge that risk buy USD and sell EUR, so that our net exposure is flat. Obviously, having an active hedging scheme is going to require more time and expertise, whether we do it using a systematic model or on a discretionary basis. We can often seek to use FX strategies that might be employed by traders to generate alpha, but limit our trades only to one side that are consistent with hedging (in our above example this would mean only entering into long USD trades for hedging). This task of applying a currency overlay strategy to manage this hedging can also be outsourced to external firms who specialise in it.


The key point is that any form of hedging (even if that is 0%) is a decision in itself. Of course, each corporate treasury team will have different mandates, in terms of the type of hedging they are allowed to do and the amounts and so on. There are also likely to be limits on the type of instruments in their mandate (eg. only cash instruments or vanilla options, rather than exotic options etc.). However, within those specific constraints, there are likely to be a range of hedging strategies that can be employed. Doing nothing is still a decision in the end!