What is a currency risk hedging and when to use it?
Currency risks are present in all foreign trading activities. In order to avoid this, businessmen and companies use hedging – a so called insurance of foreign currency exchange risks. Thus, the currency risk hedging is a protection of funds against the adverse currency movements. Hedging helps to save a present value of one currency against another one by opening a trading position in the Forex trading platform.
Thus, an enterprise manages its foreign exchange risks, and can not be afraid of changes in the currency rates. When making a goods foreign trade the participants can easily plan their financial activities and see the financial results without fear of exchange rate fluctuations.
Hedging is actively used worldwide by enterprises which are involved in exports and imports of goods. In this case, they can use several methods of hedging, such as buying futures or options, or saving the value of the currency using a Forex trading platform.
Let us look into the details of the last method. Exporters are interested to sell foreign currency, while importers want to buy it. The real cost of goods they trade is constantly changing as the rate of the currency changes too. So if the payment for goods is delayed as it happens very often with the financial transactions of imports and exports, the company can get a loss or profit due to the currency value change during the delay time.
Many large companies that make foreign trade operations have analytical departments involved in forecasting the currency exchange rate changes. But even then there is a risk of incorrect prediction, in order to avoid the risk a currency hedging is applied.
Why Forex is very popular for hedging?
The goods accounting in an enterprise is usually done in one particular currency, most often in the USD or EUR. But often there are situations when it is needed to make an exchange of EUR to USD or vice versa, as a company keeps a bank account only in one currency, but the goods will be delivered abroad after a certain period of time. Therefore, any slight change in the ratio of exchanged currencies will affect the result of the deal.
Forex market is an excellent opportunity to hedge foreign exchange risks. It has many benefits for businessmen and enterprises hedging purposes:
1. Forex trading is conducted on the principle of margin with the help of leverage that depends on the trading platform conditions. This means that trading can be done with the amount of 100-500 times bigger than the one that is in the trading account.
2. Forex trading is done without real supply of money, because once the funds are added to the trading account, you can perform a great number of operations. After closing a trading position the entire amount can be withdrawn from the account.
3. You can open positions in all currencies different from the currency of your deposit. For example, a current hedging is done for a currency pair EUR/USD, and the next transfer of the goods is going to be done in GBP. In this case a trader opens a new trading position for the currency pair GBP/USD without paying additional fees for deposit-withdrawal, because he has funds in the account.
4. Low fees on the deposit and withdrawal of funds. Usually the fees depend on the Forex broker and a Forex trading platform you are using.
Thus, hedging provides additional advantages for trading financial operations, allowing you to properly manage risk and maximize profits.