When a devaluation or upvaluation seems likely, a company must determine whether it has an unwanted net exposure to exchange risk. Management's basic objective with any exposure is to minimize the amount of probable exchange losses and the cost of protection. A hedge is an approach designed to reduce or offset a possible loss. An arrangement that eliminates translation risk is said to hedge that risk. A hedge is designed to substitute a known cost of buying protection against foreign-exchange risk for an unknown translation loss. One can use a variety of techniques to deal with translation exposure. These techniques consist of one major group of hedging devices: a balance-sheet hedge.
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