Hedging with a Forward Contract

Excel Currencies Explains How to Hedge Currency Risk

Hedging in the FX market is defined as; the act of opening one or more currency trades to offset an existing position to reduce losses. Hedging aims to reduce your currency risk to a defined level rather than necessarily eliminate it entirely.

Even while this volatility is frequently acknowledged as an inevitable aspect of the market, there are several hedging techniques that may be used to lower the amount of currency risk connected to each transaction. Hedging with a Forward Contract is one of such highly popular methods.

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What is hedging?

Hedging involves strategies to minimize the risk associated with fluctuations in currency exchange rates. Traders and investors constantly use hedging to protect against potential losses that could arise from adverse movements in foreign exchange markets.

The basic idea of hedging is to offset potential losses in one position with gains in another. For instance, if a trader anticipates that the value of a currency pair might move unfavourably, they might look to a Forward Contract to lock in an exchange rate now.

Hedging follows the idea of ‘not putting all your eggs in one basket’.

What is a Forward Contract?

A Forward Contract is a ‘buy now, pay later’ product which enables the customer to lock in the rate now and pay for the transaction at a later date.

This has many benefits including;

Saves you time looking and worrying about exchange rates
It’s useful if there are cash flow issues
90% of the remaining money can stay with the customer earning interest
It protects you from future negative current movements

Excel Currencies has been in business since 2004 and are fully authorised and regulated by the FCA. Customer funds are held in safeguarding accounts with tier 1 banks only. Excel Currencies use sophisticated anti-fraud measures to keep your money safe.

How to hedge with a Forward Contract

Forward Contract

Identify the need for hedging

Assess the risk exposure due to fluctuations in exchange rates, typically affecting businesses with international transactions or investments.

Common reasons include managing costs for import/export operations, protecting against adverse currency movements, or stabilizing profit margins.

Determine the hedging amount

Calculate the total amount of currency exposure you want to hedge. This involves evaluating the size of future foreign currency payments or receipts.

Choose the Forward Contract terms

Decide on the contract’s maturity date based on when you expect the currency transaction to occur. Agree on the forward exchange rate, which is the rate at which the currencies will be exchanged in the future. This rate is derived from the spot rate adjusted for interest rate differentials.

Calculate Forward Contract size

Based on the amount of foreign currency exposure, calculate the size of forward contract required to hedge the exposure by an amount or % you deem reasonable

Periodic Review

Regularly review the hedging strategy and forward contracts to ensure they remain effective and relevant to current market conditions and business needs.

The bottom line

Choosing the right financial solution provider is crucial when hedging with a Forward Contract. The effectiveness of your hedging strategy largely depends on the expertise of your provider.

A reputable provider offers competitive forward rates, sound advice on managing currency risks, and personalized solutions tailored to your specific needs.

Excel Currencies