Hedging Forex Risks – External Techniques

Transaction risks can also be hedged using a range of financial products −

●      Forward Contracts − The forward market is used to buy and sell a currency, on a fixed date for a rate, i.e., the forward rate of exchange. This effectively fixes the future rate.

●      Money Market Hedges − The idea is to minimize uncertainty by making the exchange at the current rate. This is done by depositing/borrowing the foreign currency till the real commercial cash flows occur.

●      Futures Contracts − Futures contracts are standard sized, traded hedging instruments. The aim of a currency futures contract is to fix an exchange rate at some future date, subject to basis risk.

●      Options − A currency option is a right, but not an obligation, to buy or sell a currency at an exercise price on a future date. The right will only be exercised in the worst-case scenario.

●      Forex Swaps − In a Forex swap, the parties agree to swap equivalent amounts of currency for a period and then re-swap them at the end of the period at an agreed swap rate. The rate and amount of currency is fixed in advance. Thus, it is called a fixed rate swap.

●      Currency Swaps − A currency swap lets the parties to swap interest rate commitments on borrowings in different currencies. The swap of interest rates could be fixed.

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