Forex Hedging

http://www.ForexConspiracyReport.com - Forex Hedging Forex hedging is the primary reason that many trade Forex. Companies that do business internationally commonly need to pay or receive payment in currencies other than their own. The problem for these companies is that in the time between agreement on a contract price for good or services and delivery there may be a substantial price change in a given currency pair. Forex hedging is done to reduce the currency risk involved in these situations. Forex hedging commonly involves Forex options trading. A possible scenario may go like the following example. A US company wishes to buy German machine parts. The two companies agree on a price to be paid in Euros to the German company by its US customer. When the parts are delivered the US company has to pay. If the Euro has risen in relation to the dollar the US company will need to pay more dollars than expected for the machine parts. The German company will receive the same amount of Euros no matter what. In Forex hedging the US company buys calls on the Euro with dollars at the time that it signs the contract to buy machine parts. It buys calls on enough Euros to pay the contract price. If, in fact, the dollar goes down and the Euro goes up in price the US Company will execute the calls on Euros and buy Euros at the exchange rate that was current when the contract was signed. It will pay the expected amount in dollars and receive the expected amount in Euros with which it will pay for the machine parts. The cost of Forex hedging in this manner is the cost of the options contracts involved. An alternative in Forex hedging is to attempt to read the fundamentals and technical factors that drive a given currency pair such as the Euro USD pair. If the individual or company believes, in the example above, that the Euro will go up in price, he will buy Euros at the time the contract is signed and hold them for later payment. The problem with simply buying Euros is that the individual or company loses flexibility. For example, let us say that in the machine parts example above the dollar rises in relation to the Euro. The individual who bought Euros early will not benefit. However, the one who used Forex hedging by way of buying calls will simply not execute the contract. He will, rather, purchase Euros, using fewer dollars than he expected to pay to buy the required amount of Euros. He will receive his machine parts as a discount because he did not buy early. He also insured himself against currency risk by purchasing calls. Forex hedging is a major part of Forex trading as it is integral to world trade for those dealing internationally to contain their currency risk while doing business in the four corners of the globe. Whether the trader seeks to anticipate price movements or use options trading as insurance Forex hedging can save substantial sums of money in doing business across borders.

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