Hedging Operating Exposure Financially: The Effect of the Abandonment Option.

The degree to which an operating exposure should be hedged financially is affected by the introduction of a valuable abandonment option. The introduction of an abandonment option does not lead to a simple reduction of the need for a financial hedging. Rather the reduction of the need for financial hedging is shown to depend upon the relative magnitudes of 1) the cash flow uncertainties stemming from the direct and indirect cash flow effects from the development in exchange rates, 2) the cash flow uncertainties stemming from other items, and 3) the cost of exercising the abandonment option.