If hedging eliminates risk but results in lower cash flow than not hedging,whether a firm hedges or not depends on:
A)the anticipated changes in the exchange rate.
B)the firm's ability to increase cash flow from other sources.
C)the firm's risk-aversion and the firm's reason for considering hedging.
D)the anticipated changes in the forward rate.

Question

Quizplus · Accepted Answer

The firm's risk-aversion and the firm's reason for considering hedging are important factors in determining whether or not to hedge. If the firm is highly risk-averse and the potential losses from exchange rate fluctuations are significant, then hedging may be necessary despite the lower cash flow. However, if the firm is more risk-tolerant and has other sources of cash flow that can offset potential losses, then not hedging may be a viable option. Anticipated changes in the exchange rate and forward rate are also important but are not the only determining factors in the decision to hedge.

If Hedging Eliminates Risk but Results in Lower Cash Flow