Accounting

Question 2

Alcatel-Lucent is one of the largest telecommunication companies in Europe. Its operations span the length of the globe meaning they find themselves exposed to several, varied risk factors. As a result it has become imperative for Alcatel-Lucent take the proper safe guards in the form of hedging, against the different risk factors they are facing currently. Especially in times of global financial instability, it has never been more important to try and combat the financial risks that face all companies through the use of derivative financial instruments.

Foreign Currency Risk

Since Alcatel-Lucent provides services in many countries worldwide, there are a substantial percentage of their assets, liabilities, revenues and expenses which are held in different currencies other than the euro and the U.S. dollar. The risk is that currency exchange rates will change after 2 companies have entered into financial obligations. Consequently, fluctuations in currency exchange rates could have a material impact on the reported results of the company. In order to combat this exposure Alcatel-Lucent implement a hedging strategy, using forward rates to lock in an exchange rate over the course of the financial obligation and thus eliminate the exposure to transaction risk.

Looking at the hedging performance of Alcatel-Lucent with regard to transaction exposure it is clear that they try and safe guard against the risk which is imposed by the exchange rate fluctuations however it has not always been entirely successful. Alcatel-Lucent enters into foreign exchange forward contracts, options and swaps to hedge against the effect of exchange rate fluctuations on cash flows denominated in foreign currencies and certain intercompany financing transactions. These transactions are designated as cash flow hedges. These cash flow hedges have had varying success for the company over the last 3 financial years. They made a loss of €1 million from these transactions in 2011 which...