Foreign Exchange Risk- Phew
24 hrs a day,fast-paced, volatile….. but most of all, extremely profitable.
However it is only profitable if you know how to manage your exchange risk by just using a few tricks and techniques available.
Exchange rate hedging is a term used by banks and other financial institutions to manage and limit losses in their foreign currency portfolios. This is most helpful if you are having an exposure on account of business transactions wherein or you are launching an offshore hedge fund which accepts various currencies.
To set up the hedge, look at a currency that has a negative correlation to your existing currency position. There are a lot of websites that provide currency correlations data and so you can choose the currency that trades in the opposite direction. The technique helps if you are keen on earning interest on your FX while moving from low interest rate currency for a particular country like US to a higher one like India. Here you are not concerned about gaining from any capital appreciation. However, for most of the companies it is not their business and it is better to outsource it or hire a professional who has been associated with the FX markets.
Another option is to purchase a forward contract in the currency you wish to buy back at a future date. By securing a future fixed price and buy-back date, you are guaranteed that rate price no matter how the currency fluctuates or settles on that date. The cost to structure a forward contract is dependent on length of the contract and can vary depending on market condition. Also your intend to hold on to that particular currency is of importance as it will give a clear picture.
Consider a derivative to hedge your currency position by purchasing a put currency option. A put option gives you the right, but not the obligation, to sell the currency at a set price, which is called the strike price, within a specified expiration date. As the option holder, you are hedging your currency position in the event that the underlying currency will drop below the strike price before the expiration date. A put option is pretty straight forward but it can be expensive depending on the volatility. Choose a strike price that closely matches your currency price. Your option position will profit after it falls below the option strike price of your currency.
Hiring an experienced Forex and Risk Management consultant will reduce the burden on the company in terms of setting up a dedicated team and a desk thus allowing to focus on business activities. A good consultant will take this ahead with appropriate introductions so as to keep your risk in check.