Honda, which ranks No. 5 in the U.S., earns as much as 70 percent of its operating profit in the world's biggest auto market. The carmaker uses hedging and financial derivatives to protect itself from currency fluctuations. This backfired when the company forecast a stronger yen this year.

"The yen weakened much faster than what we had expected and there was a difference (between) what we hedged at and how the currency fluctuated," said Satoshi Aoki, the company's executive vice president.

The Japanese currency averaged 117.23 yen against the U.S. dollar in the three months to Dec. 31, compared with Honda's original assumption of 110 yen.

This statement, issued by Honda on 31 January 2006 to accompany its third-quarter results, underlines the difficulties faced by companies - even large ones - whose decision whether to hedge their risks is determined by their market forecasts. At Financial Market Strategies, we discourage our clients from relying on forecasts, as hedging based on a forecast of a subsequent favourable exchange rate movement will be inadequate if the forecast turns out to be wrong.

For more details about our Risk Management services, please contact us.