exercise: uses of hedging exposure

[fullofquestions]

Which of the following is NOT a reason why corporates should hedge their exposures? To:
a. Facilitate optimal investment.
b. Lower the cost of financial distress.
c. Lower transaction costs. (ANS)
d. Lower the cost of corporate management.

Facilitate optimal investment and lowering the cost of financial distress makes sense. Can someone give an example of hedging exposure to the cost of corporate management? Also, considering the answer is c, can someone explain why you would not want to hedge exposure to transaction costs?

 

[notjusttp]

Hi Full of Questions,

1) Corporate management costs comprises entire gamut of costs + losses incurred by top management while running their busineses. So any effective hedge which would reduce the probability of loss of positions would necessarily go to reduce the cost of corporate management. hence d is very much a reason why corporate should go for hedging their exposures.

2) The basic layman definition of hedge is "To take compensatory measures so as to counterbalance possible loss." Transactional costs are not any possible losses but costs ( expenditure) incurred to carry out operations of the organisation and has to be necessarily incurred. The best you can do with them is to control them vide cost control measures. however hedging of costs in maximum number ( possibly all) is not possible.

Hope this helps

Best Rgds
Amit