The impact of hedge funds on financial crisis essay paper

In addition, it is necessary to remember about negative effects of hedge funds which also tend to speculations and increase the negative impact of speculations on financial markets. Pantzalis defines hedging as “the firms decisions (related to marketing, production, sourcing, plant location, treasury) that are best suited to managing the exchange rate exposure on the firm’s competitive position across the markets” (2001, p.793). He also defines the shifting of production to offset price changes with local cost changes as one of operational hedging strategies that, according to him, may be very effective particularly for large multinational firms that could combine this strategy with their flexibility that is observed within such firms in shifting production and transferring resources. From this definition we may conclude that hedging is quite effective and very important for multinational firms. Not surprisingly that the number of firms that use hedging is permanently increasing and 42% of hedging users “indicated that their usage had increased over the previous year, compared to just 13% who indicated a decrease” (Kogut and Kulatilaka 1994, p. 237). It is also noteworthy that “in the size dimension, usage is heaviest among large firms at 83%, the usage rate drops to 45% for medium-sized firms and to 12% for small firms” (Kogut and Kulatilaka 1994, p. 238). Another definition that may serve as complementary for the previous one is done by Carter who treats hedging strategies as “a combination of production and marketing strategies across the firm operating units developed to manage long-term exposures” (2003, p.178).

Thus, from the definitions given above we can see that the main points that should be pointed out and that are provided by the usage of hedging strategies are firm’s flexibility and diversification. It is evident that they may quite effective in the risk management. However, if flexibility is considered to be absolutely positive for multinational firms and their rate of benefits, the role, importance and positive effect of (geographical) diversification is still under the question. Consequently, we may say that hedging is not undoubtedly positive for multinational firms or at least that not all specialists agree at this point when they speak about such aspect as diversification that, in its turn, make multinational firms administration uncertain whether to use hedging or not. But anyway, the problem of risk management is of a paramount importance and for a majority (about 60%) of managers and shareholders it is much more important than the increase of company’s profits. However, G. Bodie and R. Merton give quite a surprising statistic according to which “40% of the firms have a profit based approach to risk management evaluation” and they conclude that “such an approach can provide incentives for risk managers to do take positions that may ultimately increase the total riskiness of the firm” (1998, p. 205). It means that the firms that consider their high profits more important than risk management are on the dangerous way, especially when we speak about multinational firm, because such a position make them the most probable candidates to undergo an economical crisis and if it is a multinational firm than the crisis may have a very serious consequences for the whole world’s economy. The recent financial crisis and economic recession have proved the negative effect of hedging, which turned out to be too risky and vulnerable to speculations and accelerated the financial crisis consistently.

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