Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

Question

Quizplus · Accepted Answer

Hedging currency exposures involves taking positions in different currencies such that the losses or gains in one currency are offset by gains or losses in the other currency. This reduces the variability of expected cash flows as the impact of currency fluctuations on the cash flows is mitigated. At the same time, the expected value of the cash flows should not change as hedging only helps to reduce the impact of currency fluctuations and not the actual cash flows. So, the correct answer is that hedging should decrease the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should not change.

Assuming No Transaction Costs (I