Indirect fundsadjustment methods

A variety of indirect funds-adjustment methods can be used to reduce foreign-currency exposure.

Exposure netting MNCs can net certain exposures from different operations around the world so that they may hedge only their net exposure. For example, when an MNC has both receivables and payables in a given foreign currency, these receivables and payables can be offset through netting, which will reduce the amount of foreign-exchange exposure. Exposure netting is a method of offsetting exposures in one currency with exposures in the same or another currency in such a way that gains or losses on the first exposure will be offset by losses or gains on the second exposure. Unlike the simple case of exposure netting on a currency-by-currency basis that we discussed above, MNCs have a portfolio of currency positions. If MNCs want to apply exposure netting aggressively, it helps to centralize their exposure management function in one location.

Leading and lagging Leading and lagging is another operational technique that MNCs can use to reduce foreign-exchange exposure. Leading means to pay or collect early, whereas lagging means to pay or collect late. MNCs should lead soft-currency receivables and lag hard-currency receivables to avoid the loss from the depreciation of the soft currency and to obtain the gain from the appreciation of the hard currency. For the same reason, MNCs will try to lead hard-currency payables and to lag soft-currency payables.

Transfer pricing Transfer prices are prices of goods and services sold between related parties, such as a parent and its subsidiary. Transfer prices are frequently different from arm's-length prices (fair market prices) so that they can be used to avoid foreign-currency exposure. For example, an MNC can remove funds from soft-currency countries by charging higher transfer prices on goods sold to its subsidiaries in those countries. For the same reason, an MNC can keep funds at those subsidiaries in hard-currency countries by charging lower prices on goods sold to its subsidiaries in those countries. Governments usually assume that MNCs manipulate their transfer prices to avoid financial problems or to improve financial conditions. Thus, most governments set up policing mechanisms to review the transfer pricing policies of MNCs.

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