If you are a person who runs large multinational companies, import and export business or large-scale currency transactions, you should have knowledge of currency hedging. In the era of globalization, this is absolutely necessary.
Breaking up is basically a risk reduction strategy. The foreign exchange rate is unpredictable and may change at any time. If adverse changes occur between the transaction date and the actual payment date, such instability may lead to significant losses. The purpose of currency hedging is to minimize risk.
Foreign exchange dumping guarantee
Like all position strategies, it also involves taking two balanced or two opposite positions in different parallel markets. Offset position or balance position means that the extra profit of another title is used to compensate the extra loss of one position.
Foreign exchange hedging policy
There are several ways to offset foreign exchange risk. They can be divided into internal strategies and external strategies. Some internal strategies include:
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According to the investor’s expectation of future foreign exchange, the investor can advance or postpone the foreign exchange payment. The depreciation of foreign exchange or, in other words, the appreciation of the domestic currency leads to an increase in payments and a decrease in income, respectively.
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There is also the concept of netting, which involves income paid in a currency, so that the loss in income is compensated by the income in payment.
External hedging strategies are more popular because they provide a wider range than internal hedging strategies. Some external strategies include:
Expiration Agreement
The fixed exchange rates for payments and receipts are fixed by these contracts. Generally speaking, the exchange rate is the foreign exchange rate determined by the market. These contracts provide stability for payment and collection. Both the recipient and the payer know the amount to be paid or accepted, and the current exchange rate on the trading day is almost irrelevant. This limits not only losses, but also extra profits. If the interest rate on the trading day was more favorable than the predetermined rate, you could have made extra profits.
Currency Exchange
These transactions occur in real time, that is, transactions occur immediately without any delay. In this case, there is the exchange of principal, and the payment of Korean currency fixer contract is exchanged with other currencies.
Foreign exchange options
Their value comes from the basic tools they represent. Therefore, the currency option is based on foreign exchange. They give the buyer or seller the right to purchase or sell specific foreign exchange, but not the obligation.
Spot contract
One way a person can protect himself from adverse exchange rates is to use spot contracts. Here, the payment and receipt of the contract are settled on the same day or one or two days after. During this period, there are few opportunities for significant changes in exchange rates, so individuals are protected from foreign exchange risks.
