Forex Hedging – What Is It?

Posted on April 30, 2010
Filed Under Currency Trading | Leave a Comment

Foreign Exchange or Forex hedging can be defined as the strategy or method used by companies to hedge (eliminate) the risks involved in the exchange or transaction of foreign currencies.

The multiple ways of forex hedging methods available to eliminate the risks associated with Forex transactions are mentioned below.

Forward Contract: A forward agreement between the currency holder and its prospective buyer will be signed in this case. And, according to it both the buyer and seller of the currency will agree for a particular rate of currency, thus ensuring the protection for seller from decrease in its price and buyer from increase in its price in the market.

Futures Trading: In this case, the trading is done on a totally different platform known as future market which is quite different from the forward agreement made between the buyer and the seller as in the case of the forward contract method. Also, futures trading will involve an initial capital outlay. The rest of the things are quite similar as is done in the forward contract method.

Options: In this case, the buyer and the seller of the currency will enter into an agreement before transaction, wherein the seller can sell his currency at a fixed rate as per the agreement if the market price of the currency lowers. Apart from this, the seller can have an option of selling his currency at higher rates and thus earning profits if the rate of the currency increases. This shall be very beneficial for him.

Swaps: In this case, the buyer and seller of the currency will enter into a contract for a predetermined period and exchange an equal starting principal amount based on the spot rate of the currency in the market. During the contract period, they share floating or fixed interests. Once the contract term is over, both the parties will re-swap their currencies with pre determined rates as per the contract, and thus end the contract having their own currencies.

Foreign debts: This is one common method used by exporters who are due in receiving a set of amount in foreign currency. Here, the exporter will take a loan equal in amount to what he is expecting to receive and get it converted to the home currency based on the current day’s rate. He will then repay the loan on receiving the due amount.

Thus, with the knowledge of all these types of forex hedging and risks involved, businessmen can earn profits and can get benefited in foreign exchange transactions.

To get ideas on how forex hedging can be done through forex software, you need check into some information. When you use forex hedging always make sure you know what your appling for, because it’s not for starters.

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