FX Hedging Strategies
Apart from sourcing better Foreign Exchange Rates, another way to better manage foreign currency exposures is through effective hedging.
There are a number of strategies that every importer and exporter must be aware of to effectively manage their currency risk. The strategies available can range from simple forward exchange contracts which provide certainty for future exchange rates and cash flow to option related strategies which can be tailored to act like a form of insurance against adverse currency movements. We can only discuss and assist with options for wholesale clients, therefore we may ask you for additional information to ensure that you fall within the definition of a wholesale client. High net worth individuals will need to provide a qualified accountant’s certificate not more than two years old(a proforma can be obtained by clicking here).
The examples we have included here are the most basic forms of hedging strategies. Strategies can be tailored to meet various hedging requirements with differing levels of complexity.
Forward Exchange Contract: Forward exchange contracts are used when one requires certainty of exchange rates at which to transact in the future. Below are examples of forward exchange rates.
Regardless of future exchange rate fluctuations, the deal would be closed at the forward exchange contract rate on the predetermined date specified in the contract. FECs provide certainty of cashflow and protect profit margins against adverse currency moves. They do not provide any flexibility for participation in favourable moves.
The above pay off diagram shows the Dealing Rate at FEC Expiry vs. Spot Rate at Expiry in 6 months. It shows that no matter where the spot rate is at expiry, the owner of the forward exchange contract must deal at the contracted rate of 0.9650.
*The above information is provided as an example only.
Example 2 – options products are only available to wholesale clients:
Options: While forward exchange contracts lock you into a rate, options allow you to benefit from favourable exchange rate movements whilst giving you protection against adverse movements at predetermined rates. Options act like insurance and a premium may be payable:
Spot rate: 0.9900
Strike price: 0.9500
Expiry: 1 month
Cost: $1,000 per USD 100,000.00 contract
The above payoff diagram shows the Dealing Rate at Option Expiry vs. Spot Rate at Expiry. At option expiry, it shows that if the spot rate is below 0.9500 the buyer of the option is protected at 0.9500. Above 0.9500, the buyer of the option will transact at the market rate and let the option expire.
Please Note: Examples are provided for illustrative purposes only and do not necessarily reflect current or future market or product movements, the price that will apply to a trade nor how such trades impact your personal circumstances.