A Fresh Look at Cross-Border Valuation and FX Hedging Decisions

We review and clarify the role of foreign exchange (FX) rates in international capital budgeting and currency risk management. We show how the outcome of an NPV analysis, from the perspective of the home currency, is affected by a misvalued current spot FX rate, or by a forecast of misvalued future spot FX rates. We also show a short-cut way to deal with converting foreign cash flow forecasts to home currency forecasts when the foreign cash flow is related to the FX rate. Additionally, we discuss a framework for incorporating the influence of FX forecasts in cross-border investment and FX hedging decisions