Forex currency hedging also known as foreign currency hedging is a Forex risk management technique in which financial instrument or strategies are used to safeguard business against potential losses caused by changes in currency exchange rates. It is commonly used by traders, investors and businesses to reduce foreign currency exchange exposure. Some of the key hedging instruments for FX exposure management are as follows:
Forward Contracts
Forward contracts are agreements uses for buying or selling an asset at predetermined prices. It allows business to lock in exchange rate for a particular date in the future. It provides better safety, certainty and stability to a business.
Futures Contracts:
A future contract is a legally binding contract between two parties to buy or sell a specific commodity asset or security at a predetermined price at a particular time.
Options Contracts:
These are contracts that provide holder the right but not obligation to exchange currency at predetermine rate before a specific date. There are usually two main types of options involved in the process: call options and pit options. The strategy employed by a trader depends upon on the option they choose and the platform through which it is offered.
Swaps
Currency swaps refers to exchanging principal and interest payments in one currency for principal and interest payments in another currency. These exchanges are valuable for managing long-term FX currency exposures. These exchanges can be tailored to match the specific cash flow requirements of the hedger.
The benefits of Forex currency hedging
It has been found in many studies that forex currency hedging is necessary for firms working in the contemporary globalized economy. Some of the benefits of currency hedging are as follows
- It improves the ability of business to forecast future cash flow requirements
- It reduces the impact of exchange rate volatility on profits
- It minimizes the need to attempt to forecast exchange rates
- It helps in reducing losses and maximizing the returns
The primary purpose of FX hedging is to safeguard investment and manage risk in financial markets. Implementing the hedging strategy effectively requires an extensive review of the company’s policies as well as the intentions of the hedge. Hedges can vary from something simple like buying a foreign currency to buying commodities in the country where company’s products are sold. You need to use a tool to bring all these things together for making an effective Forex risk management strategy.
Corphedge is an easy-to-use SaaS tool for proper FX exposure management. It allows companies to create their own FX hedging policy, set up budget rate, receive notifications, record and track hedging portfolio, get reports and valuations easily, also view sensitivity. Before hedging, companies can view what risks they are facing in the absence of hedging. If you are just beginning your hedging journey, it is essential to invest in the right tools and processes to reap its full benefits.