What is Currency Hedging?

Currency hedging is the practice of covering exposure to a risk created by having a commitment to pay or receive a currency other than your own at a date in the future.

Currency hedges may be specific to particular cash flow or bundled into a hedging strategy which covers all exposures for a particular period, say one year.

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A business which is a purely domestic business may, as a one-off, contract to buy a piece of machinery or equipment from mainland Europe or the USA. In such an instance the firm will most likely create a one-off risk to the value of the currency it has, which could see it appreciating during the period between signing the contract and making payment(s). In such a case, it is unlikely, since the business is purely domestic, that the expertise to deal with such a risk is within the company. Payment firms like CurrencyTransfer.com are able to help arrange the hedge of your behalf.

The most easily understood currency hedge is a forward contract which allows you to simply buy the currency today for the delivery on the due date(s). In this way, you know with absolute certainty how much in your home currency you will be paying.

At the other end of the scale, businesses which export their goods all over the world or import raw materials usually have a currency hedging strategy in place which suits their business needs.

In this case, there are various methodologies. For example, the firm may agree to buy a certain amount of currency monthly and arrange a price for each tranche. They can also agree to be able to take delivery at any date in a given month all at a single price for that individual period.

In most large firms, a currency hedging strategy is agreed at board level to ensure that the business is well aware of the risk profile being adopted. It could be that the firm is willing to take a small amount of risk that the currency they have to buy may depreciate, thus providing a windfall profit. However, this should only be undertaken with the full understanding and approval of the CFO, CEO and the board.

There are firms that consider not currency hedging at all, as a hedge in itself. This is something that should be approved and minuted at board level. Basically, it means that currency requirements are covered as and when needed and the firm accepts that the rate may move in their favour or against them and it is hoped that the “wins” outweigh the “losses”. This is an incredibly risky and almost foolhardy proposition since it is “nice” when the currency moves in your favour but it can move so much as to wipe out not just the profit on the individual transaction but the firm’s entire profit or even worse.

When dealing with currency hedging it pays to have as much knowledge as possible that is why CurrencyTransfer.com have advisors who are able to provide a series of alternative suggestions to allow you to make the most viable decision based upon your firm’s’ risk profile.