Why Hedge Foreign Currency Risk?

International commerce has rapidly increased as the internet has provided a new and more transparent marketplace for individuals and entities alike to conduct international business and trading activities. Significant changes in the international economic and political landscape have led to uncertainty regarding the direction of foreign exchange rates. This uncertainty leads to volatility and the need for an effective vehicle to hedge foreign exchange rate risk and/or interest rate changes while, at the same time, effectively ensuring a future financial position.

Each entity and/or individual that has exposure to foreign exchange rate risk will have specific foreign exchange hedging needs and this website can not possibly cover every existing foreign exchange hedging situation. Therefore, we will cover the more common reasons that a foreign exchange hedge is placed and show you how to properly hedge foreign exchange rate risk.

Foreign Exchange Rate Risk Exposure - Foreign exchange rate risk exposure is common to virtually all who conduct international business and/or trading. Buying and/or selling of goods or services denominated in foreign currencies can immediately expose you to foreign exchange rate risk. If a firm price is quoted ahead of time for a contract using a foreign exchange rate that is deemed appropriate at the time the quote is given, the foreign exchange rate quote may not necessarily be appropriate at the time of the actual agreement or performance of the contract. Placing a foreign exchange hedge can help to manage this foreign exchange rate risk.

Interest Rate Risk Exposure - Interest rate exposure refers to the interest rate differential between the two countries' currencies in a foreign exchange contract. The interest rate differential is also roughly equal to the "carry" cost paid to hedge a forward or futures contract. As a side note, arbitragers are investors that take advantage when interest rate differentials between the foreign exchange spot rate and either the forward or futures contract are either to high or too low. In simplest terms, an arbitrager may sell when the carry cost he or she can collect is at a premium to the actual carry cost of the contract sold. Conversely, an arbitrager may buy when the carry cost he or she may pay is less than the actual carry cost of the contract bought. Either way, the arbitrager is looking to profit from a small price discrepancy due to interest rate differentials.

Foreign Investment / Stock Exposure - Foreign investing is considered by many investors as a way to either diversify an investment portfolio or seek a larger return on investment(s) in an economy believed to be growing at a faster pace than investment(s) in the respective domestic economy. Investing in foreign stocks automatically exposes the investor to foreign exchange rate risk and speculative risk. For example, an investor buys a particular amount of foreign currency (in exchange for domestic currency) in order to purchase shares of a foreign stock. The investor is now automatically exposed to two separate risks. First, the stock price may go either up or down and the investor is exposed to the speculative stock price risk. Second, the investor is exposed to foreign exchange rate risk because the foreign exchange rate may either appreciate or depreciate from the time the investor first purchased the foreign stock and the time the investor decides to exit the position and repatriates the currency (exchanges the foreign currency back to domestic currency). Therefore, even if a speculative profit is achieved because the foreign stock price rose, the investor could actually net lose money if devaluation of the foreign currency occurred while the investor was holding the foreign stock (and the devaluation amount was greater than the speculative profit). Placing a foreign exchange hedge can help to manage this foreign exchange rate risk.

Hedging Speculative Positions - Foreign currency traders utilize foreign exchange hedging to protect open positions against adverse moves in foreign exchange rates, and placing a foreign exchange hedge can help to manage foreign exchange rate risk. Speculative positions can be hedged via a number of foreign exchange hedging vehicles that can be used either alone or in combination to create entirely new foreign exchange hedging strategies.

John Nobile - Senior Account Executive
CFOS/FX - Online Forex Spot and Options Brokerage

---

Money Management, Part 1

There are some common mistakes I've seen traders make in... Read More

10 Steps To Professional Day Trading

Everyone trades a little differently. The trading method outlined below... Read More

Getting a Forex Trading Education

Many Americans are interested in getting involved in forex trading.... Read More

A Beginner?s Guide to FOREX

FOREX is the abbreviation for the Foreign Exchange market. FOREX... Read More

The Meaning of FOREX Price Charts and How to Use Them

There is one very important factor that you should consider... Read More

Creativity in Trading

"Is it important to be creative in your trading?"I'm not... Read More

Trading Tips No 1: Learn How to Trade The Moment of Truth

So you have learned how to trade the markets by... Read More

Forex Training: Follow Your Gut or Your Broker

Which way will the forex market move? Do you just... Read More

FOREX Trading Philosophy

Keen on starting FOREX trading? Why would you not be?... Read More

Why Forex Traders Plan To Fail Before They Even Place Their First Trade & How You Can Know It & ...

Have you heard the wise saying that a trader who... Read More

How Do Other Countries Devalue Their Currencies?

Countries devalue their currencies only when they have no other... Read More

The Secret of Reduced Margin Spreads

One of the best kept secrets in trading is that... Read More

The Nature of the Trading Business

Consider the following: As a trader you are in a... Read More

Mechanical or Discretionary Trading - Which is Best?

Discretionary TradingPure discretionary trading will rely solely on the traders... Read More

Stock Market Report: Day Trading or Swing Trading Online? Stock Investing Information

Profitable day traders recognize that momentum trading is among the... Read More

Trade Exit - How To Cut Losses And Let Profits Run

Cut your losses short and let your profits run. This... Read More

Forex Currency Trading

It is possible to buy and sell money from different... Read More

Chinas New Currency Regime

The base unit for the renminbi is the yuan, which... Read More

Financial Crises, Global Capital Flows and the International Financial Architecture

The recent upheavals in the world financial markets were quelled... Read More

Two Timeless Rules in FOREX Investing

RULE #1) ~ Cut your losers; let your winners ride.One... Read More

Stopping Yourself

I read on a bulletin board a traders comment that... Read More

Forex Brokers - Helping to Maximize Your Success

A Forex broker is a broker dealing in foreign exchange,... Read More

Day Trading Course or Day Trading Technique Seminar: Learn Day Trading Education

Profitable day traders recognize that momentum trading is among the... Read More

Online Forex

Q1: When you consider that the foreign exchange market has... Read More

Your Mother Could Make Money In Forex Trading

The question would be not whether she could but rather... Read More

Business and the Forex

The business world is a complex web of supply and... Read More

Intrenet Marketing VS Forex Currency Trading

Have you noticed that when someone's trying to sell you... Read More

Hedging Foreign Exchange Risks

The exchange rate of the Macedonian Denar against the major... Read More

Forex Trading Online - 7 Reasons Why You Should!

Forex trading online is a fast way to use your... Read More

Writing A Trading Plan

All professional traders have a trading plan. Trading futures is... Read More

Experience

Throughout our course on futures trading, we have tried to... Read More

What is Forex Trading?

Forex, or Foreign Exchange, is the simultaneous exchange of one... Read More

Trading Timeframes

Long TermLong term traders will work from end of day... Read More