International Accounting (Essay Sample)

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International Accounting
Hedging is a strategy in risk management that limits or offsets the probability of loss from fluctuations in the prices of merchandise, currencies, or securities. Thus, hedging is simply the transfer of risk without purchasing insurance policies. Specifically, hedging uses a variety of techniques, but principally, it entails taking equivalent and opposite positions in two dissimilar markets like cash and future markets. It also protects a person’s capital against inflation effects through high-yield financial instruments and investments such as real estates and precious metals. The financial instruments can be in the form of bonds, notes or shares (Fischer et al. 17).
Different industries in the money market must always apply hedging to cushion themselves against dynamic trends in the financial markets. The banking industry is not exceptional in the application of hedging in their financial operations to avert opportunity loss. In the banking industry, there is a cultural fluctuation of exchange rates when it comes to foreign currencies. This implies that there are currency risks that hit the bank industry constantly when the exchange rates fluctuate (Heidrich 20).
The risks in foreign exchange occur when a bank seizes assets or liabilities in foreign currencies and affects the earnings as well as capital of banks due to the alternations in the exchange rates. The latter are always unpredictable and can take any direction despite the estimates made. In practice, the uncertainty in exchange rates appears to be a great threat to the earning and capital of a bank if their fluctuation is unplanned (Fischer et al. 30).
The various risks associated with exchange rates can be either transactional or translational. Transactional risks occur when there are changes in the exchange rate transactions that are unfavorable. Translational risks, on the other hand, are hazards in accounting that occur as a result of the translation of assets that are held in foreign currency or abroad.
Commercial banks are always exposed to the threats associated with foreign exchange rates. The Australian banking industry before 1983 is an example of a banking sphere that was successful with foreign currencies and hedging. It was after 1983 that the Australian international businesses embraced the system of floating currency. Since then, the Australian international business scope has adopted hedging as a fundamental practice in the reduction of exchange rates exposure. The Australian dollar appreciates and depreciates in a free cycle against other currencies. Thus, all the importers and exporters are exposed to the exchange rate risk as a consequence of this volatility effect. According to some researches, the Australian banking industry reported an increment in the hedging of foreign currency during the period between 1984 and 1986. This was in response to the decrease of the Australian dollar and the increase of its volatility against other currencies (Mehta and Hung-gay 18).
The Australian banking industry is exceedingly exposed to the risks associated with foreign currencies. This is because the Australian business transactions have been accounted in foreign currencies. The predominant exposure of the foreign currency in the Australian banking industry is the US dollar. Studies show that the US dollar represented a half of the foreign currency in the banking industry of the Australian foreign currency exposure. The Euros accounted for a 15% proportion. Other foreign currencies, which include the Japanese yen, the Swiss franc and the British pounds, constituted a miniature percentage as compared to the US dollar (Heidrich 36).
According to the Australian banking industry, a successful area with respect to foreign currencies and hedging entails a little but a definite loss, which is ultimately the cost of hedging. As opposed to this, there is a little prospect of a large gain without hedging. The pretext for not hedging is that people expect an uncertain outcome with a little prospect of a gain to a sure loss. Thus, explaining the problem correctly, the Australian banking industry’s investments were stronger to counter psychological tendencies in the industry to neglect hedging. However, they planned a good strategy of hedging to become part of an effective system that the Australian businesses adopt. The various incentives helped it to make hedging an established custom in the banking industry (Haller et al. 27).
An example of the banking industry that failed in foreign currencies and hedging is that of India. Some of the commercial banks in India concluded that hedging is a waste of money. This is because the intra-day volatility of currency markets in India is mostly less than the costs of hedging. However, according to the reality in the application of hedging today, the volatility of foreign currencies can increase considerably with global shocks. With this, the commercial banks in India wanted to postpone short dollar positions to wait for the markets to calm and for the hedging costs to increase. It is based on this that they came to the conclusion that hedging is expensive. Volatility is also a problem since the Indians in the banking sector weighed the unpredictable conditions in the banking industry (Heidrich 56). The various issues related to hedging rose from the impulsiveness in the foreign exchange rates of foreign currencies. Hedging resulted into incurred losses, especially with the decrease of exchange rates in the money market. In the banking industry, creditors always set their interest rates to limits that ensure that they are able to cover predicted defaults in case of bankruptcy. However...