Introduction

International investing and trade has one unintended consequence: the creation of currency risk which may cause the local currency value of a firm’s foreign receivables, liabilities or investments to fluctuate dramatically because of pure currency spot movements. In their corporate risk management survey, [364] stated that industrial corporations rank foreign exchange risks as the most costly risk with 93% of firms reporting some kind of foreign exchange exposure, and, on average, firms judging between a quarter and a third of their revenues, costs and cash flows as being exposed to movements in exchange rates. Protection against foreign exchange risks may be achieved through internal or external hedging. Internal hedging refers to the exploitation of possibilities of changing the currency of cash outflows to better align them with inflows. Instruments include invoicing imports and exports in the home currency, contracting currency and foreign exchange clauses, speeding up or slowing down payments (leading or lagging),matching or netting claims, currency reserves, changing debt/claim structures, adjusting credit conditions and prices, etc. [109, 396]. This can be done by changing vendors, by relocating production facilities abroad or by foreign-denominated debt, that is, by funding itself in the foreign currency. Such hedges can act as substitutes to currency derivatives [154, 307, 331]. External hedging instruments, besides derivatives, include export factoring and forfaiting, international leasing, and foreign exchange insurance [109]. However, because hedging normally refers to the use of off-balance-sheet instruments, that is forward-based and option-based contracts in the case of exchange rate hedging, only such currency derivatives shall be considered in the following.