Introduction

When multinational companies operate their business overseas, they will have some currency risk management activities to avoid loss. The tools and strategies often revealed in their annual reports. Nestle, Disney, Nokia and BP are the four multinational companies that we are going to discuss in this report, investigating the currency risk hedges of the annual reports. Nestle was founded in 1867, the headquarters was established in Switzerland, Vevey. Both in sales and recognition, all are ranked the world's largest food companies. Nestle operates total distribution of more than 200 subsidiaries in more than 80 countries and nearly 480 factories in the world. Nestle hired approximately 27 million employees, annual turnover of more than 107.6 billion U.S. dollars. (Nestle website, 2009) Walt Disney Company is the world's largest entertainment and media companies, and it has the second largest turnover of the company in the global media. It has a television and entertainment (the United States, one of the largest film distributors), the theme park and resort areas (the world's largest theme park group), the media network road (with one of the three major U.S. broadcasters ABC, sports brand ESPN), consumer goods (the world's largest children's consumer brand, the world's largest group of children's books), etc. Nokia has four major parts of business include internet, mobile phone, ventures organization and research and development center. Nokia's products sold in 130 countries, it has 23 production bases which includes joint ventures in 10 countries. Furthermore, Nokia has set up 55 research and development centers in 15 countries and employs approximately sixty thousand employees.(Nokia website, 2009) BP is one of the largest oil and gas companies in the world, with headquarter in London. BP does production and business activities in more than 29 countries around the world, business areas including oil, natural gas exploration and development, refining, marketing and renewable energy. BP has about ninety thousand employs in the worldwide.(BP website, 2009) There are several things in common of these four companies. First, they are one of the biggest companies in different products in the world. Second, they are big multinational companies who operate their business in the global market, so they also need to manage their currency risk in foreign circumstances.

Why hedgy?
To gain competitiveness, enterprises must go into international market, and it contributed to the growing of funds between countries. But in the process of funds movement, because of the different monetary value between countries, it will result in foreign exchange risk. Especially for multinational enterprises, the devaluation or revaluation of exchange rate will have a significant impact. To strengthen the effectiveness of the enterprises financial management, managing foreign exchange risk properly and reducing volatility exchange rate are important for multinational enterprises. When enterprises confront by changes in foreign exchange rate, they

need to take appropriate hedging strategies and select effective hedging instruments in order to attain the effectiveness of risk management. Hedging is the taking of a position, acquiring either a cash flow, an asset, or a contract (including a forward contract) that will rise (fall) in value and offset a fall (rise) in the value of an existing position. Smith & Stulz (1985) indicated that hedging can reduce the company's earnings variability, reducing the company's risk of financial crisis. The higher financial crisis of companies, they are more likely to hedge. In general, large companies will conduct more activities in the hedges. (Berkman & Bradbury,1996) For the large multinational enterprises such as Nokia, Disney, Nestle and BP, managing foreign currency risk properly is more important because they operate their business all over the world. Enterprises managers who take different hedging strategies will have huge different results and impacts. Therefore, proper hedging strategy protects companies of the existing asset from loss. There are three main reasons for these companies to hedge their foreign currency risk:

Cash flow hedge

When enterprises use currency hedging for future cash flows, it will improve the company's ability of assessment planning. By upgrading the enterprise's cash flow management, transaction exposure can be reasonably controlled to enhance the utilization efficiency of enterprise funds, thereby accelerating the development of enterprises. Enterprises could undertake further investment or activities by using hedging strategies. Enhance cash flow management is the basic requirement for survival. Every business has its own different stages of development, its cash flow characteristics are also different. A firm which has more investment opportunities will hedge in order to maintain the stability of cash flow, avoid making external financing (Froot , Scharfstein & Stein, 1993). For Disney, because of the foreign exchange rate changes in the global monetary market all the time, its goal is to mitigate earnings and cash flow fluctuations associated with currency. Therefore, the hedge enables Disney pays attention on core business issues. Nestle also uses cash flow hedges to reduce foreign currency risks of probable forecast transactions. For example, its own expected future export sales, the expenses of the equipment and raw materials. For Nokia, it used Qualifying hedges to afford exchange risk of the anticipated foreign currency denominated sales and purchases. Through the Qualifying hedges, the cash flow can undertake the loss in a higher probability when the unexpected exposure emerged. Nokia also used hedges to try to do best to avoid the foreign currency risk related with the business acquisitions and any recognition of the non-financial assets from future transactions which related with former business acquisitions or other transactions with a deferred amount from the equity to the profit or loss of the goodwill assessments. The fourth company, BP, also adopted cash flow hedges when hedging exposure to variability in cash flows that is either attributable to a particular risk associated with a recognized asset or liability or a highly probable forecast transaction. Above of all, the reduction of the risk in the future cash flow can improve the future capability of the firm to afford the loss or debt payment to ensure the company continuous operations.

Fair value hedge

Fair value refers to the buyers and sellers are all familiar with the situation of a fair deal, and then under the conditions determined by the price. Or there is no association between two companies, but an asset can be traded transaction in a fair deal condition. When exchange rate appreciate or depreciate, firms can base on the fair value contract to avoid the risk. The change in fair value of a hedging will result in profit or loss. BP and Nestle both used fair value hedges to mitigate foreign currency risks of their recognised assets and liabilities. The changes in fair values of hedging instruments are recognised in the income statement. Hedged items are also stated at fair value in respect of the risk being hedged, with any gain or loss being recognised in the income statement. Disney also used hedges of fair value exposure, it adopted the methods in order to hedge the fair value of a liability, recognized asset and a firm commitment. However, Nokia did not use any derivative related in hedge accounting of fair value to acquire profit or loss, and any revaluating of the derivatives documents was direct belonging to the profit and loss account.

Net investment hedge

Net investment is also called induced investment. A company invests some subjects in order to increase the capital, the subjects including the net increase of construction, equipment and inventory. When a company invests in foreign countries, it will face the changes of the currency value, and sometimes a currency appreciate or depreciate will bring huge loss to a company. For the four multinational firms, Bp, Nokia and Nestle adopted the hedges of a net investment in a foreign operation, the effective portion of the gain or loss on the hedging instrument is recognized directly in equity, while the ineffective portion is recognized in profit or loss. Amounts taken to equity are transferred to the income statement when the foreign operation is sold or partially disposed. These three firms used net investment hedges to reduce translation exposure on its net investments in affiliated companies. Nokias qualifying hedges are those properly documented hedges of the foreign exchange rate risk of foreign currency denominated net investments

Summary
Hekman (1986) pointed out that enterprises should avoid exchange rate risks, no matter in which countries, the important thing is the sensitivity of the international or domestic market conditions. Market has a variety of derivative instruments to manage foreign exchange rate risk, the problem is the enterprises on their own circumstances need to make the most appropriate exchange rate risk hedging.

Need an essay? You can buy essay help from us today!

Read more: http://www.ukessays.com/essays/finance/multinational-companies-and-currencyrisk-hedges-finance-essay.php#ixzz2iNAT5CRl