The Use Forex Trading as Hedging of Currency Risks

Companies engaged in foreign trade transactions worldwide are active participants in international Forex market. For exporters, there is a constant need to sell foreign currency, while importers - buy it. Currency exchange rates in the international currency market are constantly changing. As a result, the real value of buy or sell a currency for the goods or services can significantly change and profitable contract may not be profitable or unprofitable. Of course, and can reverse the situation when a change of exchange rates makes a profit, but the task of trading company is not profit from changes in exchange rates. For commercial companies, it is important to be able to plan the real cost of buy or sell a product, so the company is widely used in its operations hedge currency risks. Cash, as well as future income or expenses in foreign currencies subject to exchange rate risks. Normally, accounting for the company is in one currency (for example, in United States dollars), thus resulting from the revaluation of articles in foreign currencies may gain or loss when changing rates of these currencies.

Hedging currency risk

Hedging currency risk - is protected from adverse movements in exchange rates, which is to fix the present value of these funds by entering into transactions on the Forex market. Hedging leads to the fact that the company disappears risk rates, which makes it possible to plan activities and to see financial results are not distorted exchange fluctuations. Transactions in the Forex market are carried out under the principle of margin trading. This trade has a number of features, which made him very popular. A small start-up capital allows the transaction to the amount many times (in the tens and hundreds) of its excess. This surplus is called Leverage (Leverage). Trade is conducted without real money supply, which reduces overhead and provides an opportunity to open positions as buying or selling currency (including different from the currency deposit). A feature of hedging currency risk through transactions without the actual movement of funds (using leverage) you can not divert traffic from the company’s significant money.

There are two basic types of hedging - hedging buyer and seller hedging. Hedge buyer used to reduce the risks associated with a possible rise in the prices of goods. Hedge seller is in the opposite situation - to limit the risks associated with a possible decrease in prices of goods.

The general principle of hedging in the foreign trade transactions is to open foreign currency position on the trade account aside for future operations conversion of funds. The importer must buy foreign currency, so it opens up the position of pre-buying the currency on the trade account, and when the moment of real buying the currency in his bank, closing the position. Exporter must sell foreign currency, so it opens up the position of pre-selling the currency on the trade account, and when the time of the sale of real currency in his bank, closing the position.

September 25, 2008 by FXcaliber

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By: Tanya Decker and Javen Mccall - school of Mathematics, King College, May 22, 2008