Fully explain what the following sentence in the chapter means: "The ongoing operations of U.S.-based Genentech gave Roche a huge, long-term U.S. dollar exposure. Roche financed the Genentech purchase with a short-term U.S

Question

dollar bridge loan, which left the company vulnerable to increasing interest rates. To protect the Swiss franc value of Genentech's anticipated long-term cash inflows, Henri Meier set up a natural hedge by creating offsetting, long-term liabilities in U.S. dollars." Why was Roche vulnerable to increasing interest rates? Explain what a natural hedge is and how Roche used it?

Answer 1

For Swiss-based Roche, Genentech was a large U.S. dollar investment that earned considerable U.S. dollar cash flows. Roche issued long-term dollar-denominated debt to hedge these long-term dollar assets, expected dollar cash inflows, exchange rate risks, and interest rate risks. In this way, Roche's expected dollar cash inflows were more evenly matched with its dollar outflows. With regard to its balance sheet, this large U.S. dollar liability helped Roche neutralize the long-term translation exposure the company took on when it acquired Genentech's long-term U.S. dollar assets.
A natural hedge is an on-balance-sheet position, which creates assets or liabilities that offset changes in expected future cash flows caused by changes in market variables, such as exchange rates and interest rates.