Explanation:
Hedging reduces the volatility of earnings/cash flow and allows the firm to increase its debt capacity instead of decreasing it. Firms with less volatile earnings can increase economic growth by acquiring more debt with fewer conditions and lower borrowing costs.
Option A is accurate: Hedging helps lower the cost of capital mainly through the lowering of bankruptcy risk and agency costs.
Option C is accurate: At times, hedging with derivatives such as swaps and options is cheaper than insurance policies. The total cost of insurance over the investment horizon may exceed the estimated losses.
Option D is accurate: When risks are controlled, the board is able to come up with more precise investment budgets, thereby improving its overall financial planning for the company. The board is unlikely to be forced to allocate more funds to a project because of incurring losses.
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Q.84 GBL Corp. has presented to its board of directors four advantages of hedging risk. Which of the following advantages is most likely incorrect?
A
Hedging risk exposure can help the firm lower its cost of capital.
B
Hedging reduces the volatility of earnings/cash flows and allows the firm to reduce its debt capacity.
C
Hedging with swaps and options is at times cheaper than insurance.
D
Hedging improves financial planning by the board of directors.
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