Why are Transfer Rates Important in Forex Hedging?

Why are Transfer Rates Important in Forex Hedging?

08 May 2020 05:21 PM

What are transfer rates?

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. Amongst many others, the government policies and growth made by one nation constitutes its economic activity. A nation may grow at a different pace when compared to other nations due to many factors – some natural while some political. Natural resources like oil, gold mining, may act as an advantage for a nation, while rich fertile terrain may work in favor of the other. Optimum capitalization of these resources will work towards sustainability first and then growth of the country. The performance of the nation may attract foreign investors when the policies are suitable and implementable. Thus the exchange rate of nation varies with respect to another and further fluctuates due to daily economic, political, interest rates, recession or growth, etc factors.

With the advent of technology, the reach of information is of high importance and thus leading to quicker actions. Amongst financial markets, the currency market has the highest volume due to its trading hours. Currency markets are open across the globe for 5 days for 24 hours. This encourages participation of traders irrespective of the region and thus while you are sleeping, other markets make the volumes. Bigger markets like European and American comprise more volume than others. Starting the trade earlier than others, Asian markets also contribute to the volume in the currency markets.

Flexible or fixed exchange rate

Exchange rates are flexible or fixed or somewhere in between depending on the exchange rate policy being adopted by the country. Majority of the economies follow a flexible exchange rate wherein the transfer rate derives its value, i.e. rises or declines based on the economic factors. Currency values change constantly (within seconds) purely due to demand and supply. Demand and supply depends on the changes within the country with respect to the economic, political, natural factors. A change in political party or a natural event like hurricane or tsunami or man-made pandemic like the Coronavirus has caused volatility in the markets. Flexible exchange rates are also called as floating exchange rates.

A country which follows a fixed exchange rate regime would be stable when compared to a flexible one, but would not get the benefit of higher volumes. The control on the exchange rate against other currencies is termed as fixed exchange rate. The traders will not see any opportunity of profits and thus would prefer to go for semi or flexible exchange rate regime economies.

Exchange rate quotes

When one needs to exchange a currency for another, they go to a bank, which in turn get the quotes from the forex markets. But is that what is quoted to the end user be it an individual or a corporate? Forex market comprises of brokers who act on behalf of banks and large corporate or institutions. They give their quote and then when currency is exchanged at that price that becomes the exchange rate deal. Often, large volume transactions are made of many low volumes transactions. Ideally irrespective of the volume, the bank should quote the real time exchange rates to the end user. A corporate due to sheer volume, tends to get a rate closer to or at the exchange rate price, but a retail price is often quoted a much higher rate when buying and lower rate while selling the currency in exchange of another. Thus a forex advisor comes in handy while dealing with foreign exchange. They bring the market closer to the client without any delay than what is quoted at the exchanges.

Sourcing the real time rates is of importance as many financial institutions like banks mark up the buying quote or the ‘ask’ quote and over and above that a bank margin is added. This bank margin is mutually fixed between the bank and the client. The volatility in the spot price leaves room for wider quotation and many small and medium enterprises specially, are quoted a price which is far from the real time exchange or transfer price.

While transacting in the forex markets, the trader may have to incorporate some forex trading techniques to ensure the forex portfolio is hedged and has relevant stop losses in place to ensure some security to the portfolio. The chances of losing the initial trading amount are high when the trading is done without any analysis. Basic fundamental analysis, technical analysis – trend, momentum, range trading, etc are utilized to ensure protection from high volatility specially during uncertain times. Coronavirus and its widespread had led global financial markets to fluctuate drastically over the last few months hitting circuit breakers and causing jitter and turbulence to the traders. Sleepless nights were finally at abeyance once central banks came to stabilize the markets through the stimulus packages.

One should look at the real time FX rates while exchanging currencies so that the prevailing rates are quoted by the bank than agreeing to pay at some card price as quoted by bank. Checking will ensure one can plan hedging for future receivables or payables. Thus getting forex rates is the first step towards foreign exchange hedging.

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