Currency exchange risks can be reduced through hedging
As countries increasingly become more interconnected, and cross-border flows of capital, people, goods and services rise, the foreign exchange market, also known as FX or Forex market, becomes indispensable. Because exchange rates of major countries float freely, there are risks inherent in any currency exchange transaction--it's possible that you will get a worse exchange rate than you planned for. Fortunately, there are certain ways to decrease, or hedge, your FX risks.
Instructions
1. Identify your foreign exchange exposure. Analyze what cash flows are exposed to foreign exchange risks. What exchange rates are they exposed to? To what extent? Also review experts' forecasts with regards to the likelihoods of exchange rate movements, and calculate their possible effects on your holdings.
2. Come up with a list of possible hedging options and construct your hedging strategy. Research hedging instruments. The primary FX hedging instrument is an option, which gives the buyer the right, but not the obligation, to sell a specified a amount of currency at a certain price (strike price) by a certain date (maturity).
3. Carry out your hedging strategy. Follow developments in the Forex market and adjust your strategy accordingly. Perhaps the volatility of a currency pair will increase the need to buy additional FX options, or the exchange rate will move in your favor and less hedging will be necessary..
