HedgeTalk: Five Mistakes Companies Make When Hedging Financial Risk
Minneapolis, MN | March 28, 2024 | By: John Trefethen, Director and Co-Founder
Hedging interest rate, currency and commodity price risk are common practices for many companies. However, mistakes can occur during the hedging process which can lead to financial loss or missed opportunities. Here are five common mistakes companies make when hedging financial risk:
Over-hedging or under-hedging. One of the most common mistakes is misjudging the amount of exposure and either over-hedging or under-hedging that exposure. Over-hedging can result in unnecessary hedging costs and the loss of the ability to apply hedge accounting. Under-hedging leaves a company exposed to market volatility.
Not having a clear hedging policy. Without a clear hedging policy in place, companies may make ad-hoc decisions or lack consistency in their hedging approach. A well-defined policy will outline the company’s objectives, risk tolerance, preferred hedging instruments, and procedures for implementation and monitoring.
Lack of monitoring and adjustments. Markets are dynamic and can be volatile, so failing to monitor market movements and adjust hedging positions accordingly is a common mistake.
Inappropriate hedging instruments. Choosing the wrong hedging instrument can lead to ineffective risk management. Each hedging instrument has its advantages and disadvantages, and companies need to consider factors such as cost, flexibility, counterparty risk and the companies risk tolerance when selecting the appropriate instrument.
Not applying hedge accounting. Without hedge accounting, companies are required to report in earnings the changes in the market value of their hedging instruments. Applying hedge accounting will minimize earnings volatility from a hedging instruments changes in value as well as enhance the transparency reported in a company’s earnings.
By avoiding these common mistakes and implementing sound hedging practices, companies can better manage their interest rate, currency and commodity price risk and protect their bottom line. If you are uncomfortable with any of these concepts consider outsourcing that task to a service provider that is well-versed in that area.
Author: John Trefethen, Director and Co-Founder
Mobile: 612-868-6013
Office: 952-746-6040
Email: jtrefethen@hedgestar.com
HedgeStar Media Contact:
Megan Roth, Marketing Manager
Office: 952-746-6056
Email: mroth@hedgestar.com
Check out our services: