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CMA Final · Strategic Performance Management and Business Valuation · Corporate Risk Management Performance

Sundaram Textiles Ltd estimates that a currency movement could cause a loss of Rs 60 lakh with a probability of 0.25 in the coming year. It can buy a forward cover costing Rs 12 lakh that eliminates the loss completely. Using expected monetary value as the only criterion, which decision is correct and what is the net advantage or disadvantage of hedging?

Sundaram should hedge. The expected loss without cover is 0.25 times Rs 60 lakh, which is Rs 15 lakh. The forward cover costs Rs 12 lakh, so hedging gives a net expected gain of Rs 3 lakh under the expected monetary value criterion.

  1. ADo not hedge; expected loss of Rs 15 lakh is lower than cost, saving Rs 3 lakh
  2. BHedge; expected loss of Rs 15 lakh exceeds the cover cost of Rs 12 lakh, a net gain of Rs 3 lakhCorrect
  3. CHedge; expected loss of Rs 60 lakh exceeds the cost, a net gain of Rs 48 lakh
  4. DDo not hedge; expected loss of Rs 12 lakh equals the cost, so there is no difference

Explanation

Expected loss = 0.25 x 60 = Rs 15 lakh. Hedging costs Rs 12 lakh and removes the expected loss, so net gain = 15 - 12 = Rs 3 lakh. Option C ignores probability and uses the full loss; option A reverses the comparison.

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