Should companies hedge against foreign currency risk?

To consider whether companies should hedge, we must first establish what hedging is. Hedging is considered to be making an investment to reduce the risk of adverse price movements on an asset. One of the risks associated with hedging is the risk from change in currency in foreign currency transactions.
There are three exposures that companies hedge against relating to foreign currency transactions, these are transaction exposure, translation exposure and economic exposures.
Transaction exposure relates to the exposure created when the company has agreed to either receive payment through foreign currency, or to make payment in foreign currency. Simply put, if you were to purchase a product or service from a foreign country and agree to pay them in their currency, but you weren't required to pay until 30 days, there is a risk that the payment you have agreed to make now, will be higher in 30 days because of the exchange rate.
Translation exposure relates to translation the company's foreign subsidiaries from the foreign currency to the currency that the parent operates under. What the company risks is the subsidiaries loosing value because of the exchange rate.
Finally, economic exposure arises because the trading position of the company becomes at risk to adverse changes in the short and long term movements in the exchange rates.


What is essential to remember when deciding whether company's should hedge away this risk, is that the exchange rate, although slightly predictable, can swing either way and the company could be hedging away a gain.


The main argument against hedging is that shareholder's can hedge their own risk by creating an investment portfolio. Although I agree with this argument, to an extent, my opinion is why should a company bear unnecessary risk by not hedging, because the impact it will have on individual shareholder's won't be severe because they have undertaken their own hedging? It is my opinion, that the company should not bare the risk and that necessary hedging is important in success.


Although fuel hedging is not the same concept as hedging against exchange rate risk, the example I will introduce exemplifies my argument. The price of fuel has seriously affected the airline industry and Southwest Airlines has managed to successfully hedge against the risk from fuel prices. Since 1999, Southwest Airlines has managed to save around $3.5 billion. My argument is, because the price of fuel can rise and fall, Southwest Airlines may have missed out on some gains, but by hedging the amount they have saved outweighs the gains. In essence, surely avoiding losses is more important than taking advantage of gains? I suppose that is at the indiscretion of individuals as to what risk they are willing to take!