Knowledge Centre

  • Knowledge is power
  • Information is liberating
  • Education is the premise of progress, in every society
Currency Hedging | December 03
Currency Exchange Hedging Strategies x Trading?

Hedging Strategies

A concept referring to the rules and procedures adhered by the investors or traders involved in the international business. This is followed to protect the profit of the investors trading in the foreign currency from the fluctuations. The currencies are volatile in value and this can pose risks to the investors, currency traders, importers, exporters, and domestic companies that use foreign products or services. 

There are primarily three risks involved when dealing with foreign currency- transaction, translation, and economic risks. Transaction risks pose a threat to investors, market traders, importers, and exporters. The risk of losing profit margins because of currency appreciation or depreciation is called a transaction risk. 

Whereas the translation risks are those which are incurred when there is an investment in foreign assets like real estate. If the foreign currency depreciates, the investors lose a part of its investment only because of currency translations. The economic risk is the sensitivity of the firm’s present value of future cash flows to the changes in exchange rates. 

To avoid such risks and make the cash flows more predictable, currency hedging is followed by the investors and companies. This is not any means to make more profit, but only a way to minimize losses. This is the reason few investors prefer to hedge a percentage of their portfolio so that there is still room for some additional profits (and even losses).

What are the types of strategies?

In foreign currency hedging, there is a set of financial contracts or agreement means to exchange currency at the fixed price. Some necessary and dynamic strategies are:

  1. Forward Contract: These are the most commonly used contract between the parties involved in hedging. The financial agreement which allows the counter party to exchange a fixed quantity at the pre-defined rates after a specified time. This helps in locking the currency rates and prevents future cash flows.

  2. Future Contract: These are the standardized contract, which works similarly as the forward contract. They are more liquid as they are traded on stock market exchanges, unlike over-the-counter trades. One can easily hedge the depreciation by selling the future while appreciation by buying the future.

  3. Currency Options: These are the financial contracts that provide the holder with the right to buy and sell the currency at a specified rate for a fixed period. The specified rate is called the strike price, based on which the holder can decide. The holder is provided with the right but not an obligation to exercise the contract. If the exchange rate is in favour of the holder, they can even skip exercising it and let it expire. To enter this contract, there is a prepayment in the form of a premium from the buyer to the writer. 

  4. Currency Swaps: The financial contract that enables two parties to exchange a series of cash flows of one currency to the series of cash flows of another currency over a specified time. Each party is liable to pay the interest for the exchanged currency at a regular interval of time during the term loan. 

  5. Foreign Debt: This is taking a loan in the foreign currency to hedge against future fluctuations. For example- an exporter is expected to receive a payment in USD at a future date. If the USD depreciates, then the company has to suffer losses purely due to currency rates. In order to protect oneself, the company can take a loan in USD for the same period and convert that into the domestic currency at current exchange rates. In the future date, when the exporter receives the payment, this can be hedged by paying the loan off in USD.

  6. Cross hedging: This is done by entering into two positively correlated currencies with opposite positions. When the currencies are positively correlated, they move in the same direction hand in hand. It is an important technique and used by those currencies whose hedging is not possible otherwise.

  7. Currency Diversification: Investing in the securities denominated in different currencies is called currency diversification. This way a company is exposed to the international markets along with mitigating the risks.

COMMENTS

No Comments Found

Contact Us

img
img
img
img
img
img
img

Important Message The information contained in this file is provided for informational purposes only, and should not be construed as legal advice on any matter. The content and interpretation of the law addressed herein is subject to revision. We disclaim all liability in respect to actions taken or not taken based on any or all the contents of this file to the fullest extent permitted by law. Every effort is made to avoid errors. In spite of that, errors and discrepancies may creep in. It is expressly stated that neither Findoc Investmart Private Limited nor any of the contributors of updates will be responsible for any damage to anybody on the basis of this document. Readers are, therefore, requested to cross check with the original sources e.g. Government publications, Orders, Judgments etc., before taking any action or making any decision. These services are being provided through our group companies Findoc Capital Mart Pvt Ltd and Findoc Finvest Private Limited

Attention Investors
  • 1. Stock Brokers can accept securities as margin from clients only by way of pledge in the depository system w.e.f. September 1, 2020.
  • 2. Update your mobile number & email Id with your stock broker/depository participant and receive OTP directly from depository on your email id and/or mobile number to create pledge.
  • 3. Pay 20% upfront margin of the transaction value to trade in cash market segment.
No need to issue cheques by investors while subscribing to IPO. Just write the bank account number and sign in the application form to authorise your bank to make payment in case of allotment. No worries forrefund as the money remains in investor's account."
Prevent Unauthorized Transactions in your demat account --> Update your Mobile Number with your Depository Participant. Receive alerts on your Registered Mobile for all debit and other important transactionsin your demat account directly from NSDLon thesame day......................issued in the interest of investors."

Findoc Commodities Pvt. Ltd.

Registered Office :

4th Floor.Kartar Bhawan. Near PAU
Gate No.l. Ferozepur Road, Ludhiana -141001.

FINDOC INVESTMART PVT. LTD./FINDOC FINVEST PVT LTD.

Registered Office :

SCO 210-211, Sector 34-A Chandigarh-160022

Corporate Office :

4th Floor, Kartar Bhawan, Near PAU Gate No.1, Ferozepur Road Ludhiana -141001.