The following are sensible reasons for a firm to engage in hedge transactions:

Question

Quizplus · Accepted Answer

Engaging in hedge transactions will reduce the risk of financial distress and mitigate agency costs, as well as minimize fluctuations in income. By hedging, a firm can protect itself against adverse fluctuations in exchange rates, interest rates, or commodity prices, which can affect its profitability, cash flow, and ability to make debt payments. This helps to reduce the risk of financial distress, as it avoids the need for a firm to resort to costly financing, such as issuing additional shares or taking on high-interest debt, to cover its losses. Additionally, hedging can mitigate agency costs, such as those arising from conflicts between managers and shareholders, by aligning the interests of managers with those of shareholders and reducing the incentives for managers to pursue their own interests at the expense of shareholders.

The Following Are Sensible Reasons for a Firm to Engage