Companies that conduct business abroad run the risk of being exposed to currency rate fluctuations when the income they earn from international deals are converted into the money of their domestic country. Similarly they stand to lose when payables are converted from their domestic currency to the currency of the destination country. One way to minimize this risk is by using currency hedging tools which are used to avoid or limit potential losses on a foreign exchange transaction. Since they are varied, one needs to cover all options carefully to decide which will work best for you.
This mode of transfer in a way hedges against the exposure associated with exchange rate fluctuations and also ensures the receipt of the foreign exchange, albeit at much better lending rates. Moreover, since they are considered to be transactions in foreign exchange, forex hedging is not required to be reflected in the balance sheet of a company as per law.
How to buy and use forex hedging
It is important to remember that forex hedging is not a tool to make money, but a strategy to protect from losses. Significantly, most companies protect only a portion of their currency to hedges as there are costs involved which can outweigh the returns at a certain point.
The main methods of hedging currency trades are as under:
- Spot Contracts: Preferred mainly by forex retailers they are not a popular option as they have a very short delivery date of two days.
- Foreign currency options: One of the most popular methods of currency hedging as they give the purchaser the right, without any obligation, to buy or sell the currency at a decided exchange rate within a set time frame
How to choose your Fx hedging provider?
A good hedging provider should assure a bundle of services that address every step of the company’s exposure to set up a formal policy. A few criteria to consider:
- Will you have direct access to experienced traders
- The experience the provider has in the particular industry.
- How fast can the provider get live executable quotes.
- If the provider has sufficient resources to address settlement issues and ensure that contracts go through on the required date.
- Will you get regular reports on the provider’s transaction history and outstanding trades.
Best brokers to hedge forex with
If you are a trader who does business abroad online, then selecting the best forex broker to hedge a currency will depend entirely upon the country of your residence. Here is our ranking for the top three brokers for hedging:
- Moneycorp: allows you to limit your FX exposure with a range of tools and options. Forward contract allows you to buy currency on a pre decided rate to be lifted by an agreed future date, which could be as much as two years. Spot Contract is an arrangement between the seller and the FX provider to purchase currency at current rates for imminent payments. Market Order can help you get a better deal if you like a particular exchange rate but don’t need to purchase straightaway. Moreover they support 120 currencies, have offices in major cities in the world, are FCA authorised and are in operation since 1979.
- TorFX Logo: Registering and trading with TorFX is extremely simple. You can open an account within minutes online or over the phone. Secure a rate with the Account Manager, make a transfer and that’s it. They provide 24×7 service, offer free currency transfers at excellent exchange rates and have a high credit rating. TorFX Logo supports 59 currencies, global network, except the US, FCA authorised, enjoy a high rating and provide strong guidance.
- Currency Solutions: They have a special knowledge of the market, and provide a dedicated portfolio manager, fast, easy and secure cross border payments, excellent rates and no fees on transfers over £3,000. Supports 121 currencies, accepts corporate clients and none from the US. Is FCA authorised, keeps exchange rate margins between 0.25% to 0.15% for large transactions and enjoys a high rating.
Forward Contracts- Currency Hedge 101
Forward Contracts are basically a “buy now, sell later” deals which enable an individual to essentially fix an exchange rate at a predetermined date in the future, usually between 12 to 24 months ahead. The contract is between two parties, one which agrees to buy the currency on the agreed future date and the second party which agrees to sell the currency at that time. A Forward Contract is also referred to as a foreign exchange contract (FEC).
The Forward Contracts are calculated on a system that adopts the market spot rate, known as ‘forward point’, to decide the forward rate. When forming the FEC, the difference between the two currency pairs and the maturity period is calculated by using a standard formula recognized all over the industry. Once the pairing is complete, the total amount traded at the agreed exchange rate is used to form a binding contract which stands automatically agreed.
While this system has its advantages, there are certain drawbacks too, in case where the rate fluctuates unfavourably in future. This is why a 10% deposit is often taken at the beginning of the deal, as the Forward Contract can then end up in a loss, except for Moneycorp which does not take anything upfront.
A Limit Order is used in the forex hedging market in the same way as investors use them in the stock market. This order offers the investor an opportunity to set the minimum or maximum price at which they would like to buy or sell. Keep in mind that a Limit Order does not guarantee your exit or enter point unless the specified price is met.
Limit Orders also help investors in buying or selling assets at a specific price or even better. These orders are very useful to investors and frequently used as they reduce the risk of trading while securing profits.