Many MNEs have established rigid transaction exposure risk management policies which mandate proportional hedging (a percentage of existing transaction exposures). Explain the pros and cons of proportional hedging

What will be an ideal response?

Answer: First of all, hedging is expensive. These policies generally require the use of forward contract hedges on a percentage (e.g., 50, 60, or 70%) of existing transaction exposures. As the maturity of the exposures lengthens, the percentage forward-cover required decreases. The remaining portion of the exposure is then selectively hedged on the basis of the firm's risk tolerance, view of exchange rate movements, and confidence level. Although rarely acknowledged by the firms themselves, selective hedging is essentially speculation. A significant question remains as to whether a firm or a financial manager can consistently predict the future direction of exchange rates.