Companies related to international trade face the constant threat of transaction exposure risks. And this is actually not a new fact. Logically thinking, it is mundane to keep fretting over risks, isn’t it? Rather than doing so, it is better to keep an eye on the volatility of forex rates and channelize one’s energy towards coming up with some workable solutions that helps one mitigate risks and not toss profitability margins.
The risks concerning transaction exposure is closely related to foreign exchange rate and this imposes threats in cross currency transaction. Taking such in mind, derivative tools are commonly used by corporations to limit their exposure to any adverse movements occurred due to change in exchange rate. However, the use of derivative tools cannot be a random or instinctive.
It requires a lot of brainstorming and here is where Forex Managers and experienced Advisors are simply at their best. The hedging strategies they adopt are purely based on the economics of real time market situation as well as technical analysis of the market to achieve both short term and long term goals. Nothing miraculous though, but it is all a game of field expertise and experience that works the tricks here.
Futures contracts are available only in certain size of transaction exposure, maturities and currencies. Unlike forward contracts, this contract are traded on an exchange which has a liquid secondary market that makes them easier to unwind or close out in case the contract timing does not match the exposure timing. In addition, the exchange also requires position takers to post bond (margins) based on the value of their positions. This is what virtually eliminates any kind of the credit risk involved in trading in futures.
There are various kinds of options depending on the exercise time, the determination of the payoff price or the possibility of a payoff. A popular exotic option that corporations make use of is the basket rate option. Instead of just buying options on a bunch of currencies individually, the firms can buy an option which is based upon some weighted average of currencies that match its transaction pattern. Here again, since currencies are not perfectly correlated the average exchange rate will be less volatile and this option will therefore be less expensive. Firms can take advantage of its own natural diversification of currency risk and hedge just the remaining risk.
The key difference between Options and Futures contract was covered by us in our previous piece in detail. (Refer to the piece(Currency Options & Futures) for more details)
For example: If any corporation has an agreement to pay foreign currency at a specified date in the future can determine the present value of the foreign currency obligation at the foreign currency lending rate and then convert the appropriate amount of home currency based on the current spot exchange rate. Such helps the company in converting the obligation into a home currency payable and eliminates all exchange risks. Similarly, if any corporation has an agreement to receive foreign currency at a specified date in the future can determine the present value of the foreign currency receipt at the foreign currency borrowing rate and borrow this amount of foreign currency and convert it into the domestic currency at the current spot exchange rate.
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For Corporations, managing transaction risks becomes taxing only when they are unable to predict which way the exchange rate will move. For some companies, it is actually a complex process as well as expensive and time consuming task to manage foreign exchange risks. Although, they may have a fair knowledge on the standard derivative tools but how and when to use them becomes an unnerving thing for them. Here however taking up a step forward to getting associated with a Forex Advisory firm turns up beneficial for the corporate.
Forex Management Service Providers come up with a pool of complementary services apart from risk advisory services. The packaged services help corporate stay at ease because of the following reasons-
Thus, for the corporate, it is always best to outsource Forex Services to deal with Forex and risk management. This will help them manage risks at a reasonable cost and more importantly, to take wise decisions related to purchase of foreign exchange hedging instruments. Isn’t this that you wanted so long?
11 Aug 2020 07:01 PM
Currency trading, often referred to as foreign exchange or Forex, is the purchase and sale of currencies in the foreign exchange market, with the objective of making profits.
21 Jul 2020 06:13 PM
A country’s exchange rate and its imports and exports hold a complicated relationship as there is a constant feedback circuit between the way a country’s currency is valued and the international trade.
29 Jun 2020 05:35 PM
Dynamic hedging is a foreign exchange risk management strategy that allows businesses and individuals to readapt their hedging positions to evolving market conditions by providing flexible solutions to protect investments from exchange rate risks.
19 Jun 2020 05:01 PM
Management of Currency Exchange Risk is of paramount importance during turbulent times, like this pandemic. The currency fluctuations are very volatile and cannot be predicted as the circumstances are uncertain.
06 Jun 2020 03:59 PM
Outrights, in FX markets refer to the type of transactions where two parties agree to buy or sell a given amount of currency at a predetermined rate, on a specified date in future.
08 May 2020 05:21 PM
Converting one exchange rate into another at a particular price makes transferring rates. Ideally all nations should be treated as equal and there shouldn’t be any exchange rate applicable which would mean to have a universal currency.