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Posts Tagged ‘hedging’
The Existence of Foreign Exchange Market
Foreign Exchange or the Forex market is one of the biggest markets in the world in the current times. While the Forex market deals with the exchange of currencies there are other financial markets that deal with various other things. Other major market holder is the Stock Exchange Market which deals in the trade of stocks and bonds. Then there is Gold Market, which trades with gold, silver, bronze, platinum, etc. Yet another market is the Futures Market, this market deals in things like oil, cotton, agricultural products, etc. Then there is interest market and also option market. But as mentioned earlier out of all these markets, Foreign exchange market is the one that holds a major market share.
Foreign Exchange market deals with the trade of currencies. The existence of the Foreign exchange market is based on a lot of factors. Few of them are mentioned below.
- Trade
Trade is one of the biggest factors that influence the Forex market. Import and export of goods and services from one country to the other requires the exchange of currency. If suppose a commodity is to be bought from the U.S. by an Indian trader. He will have to pay the amount in dollars. This is to say that in this business people need to exchange different currencies in order to keep their trade going. Therefore the currencies that they have need to be converted into the currency of the country where they wish to buy the products or services from. This is where the role of Foreign Exchange Market comes in.
- Fluctuation in the Exchange rates
There is a speculation in the exchange rates depending upon the demand and supply. The more a currency is in demand the higher would be its value and vice-versa. Therefore, based on this, there is speculation in the Forex market.
- Hedging
By means of this method the chances of risk are minimized. Hedging is a technique used by various Foreign Exchange traders in order to sustain in risky situations. This is a very useful tool for traders. Hedging does not mean that the risk is lowered in terms of fluctuation of exchange rates. But it is a tool that offers the relaxation of trading freely as even if there is a risk of market trend going downwards, one will not be in much loss.
- Development of Foreign Exchange Market
The Foreign Exchange market has gained momentum slowly and stands tall in the financial sector in today’s date. The speculation of the Exchange rate is increasing at a fast speed. It is this speculation that has given rise to the number of investors in this market. Fluctuation is one factor that shows that this market is full of opportunities. This is the sole reason why more and more individuals these days are investing in the Forex market and the market is growing at a fast pace.
All about Forex hedging
There is certain amount of risks involved in hedging but they are not much. If you pay attention to the basics, these risks can be controlled. The risk occurs from the incorrectness of the prediction and can sometimes lead to unanticipated price fluctuations. Suppose a company purchases over forecasts and hedges with forwards, the profit or loss involved with the hedge will be more as compared to the variance. If you do over forecasts and the dollar strengthens then you will have to face a loss on forward contracts and vice versa if the dollar weakens. The overall profit or loss will be around the percent over forecasted times the percent that the dollar changed i.e. a 30% currency strengthening and a 40% over forecast will result in 6% extra cost of the parts.
You must buy some of the parts at the spot rate when under forecasting without a counterbalancing hedge. They will be cheaper if the dollar strengthens and more expensive if the dollar weakens. If you select the proper currency, you can surely earn great profits. If you are a good speaker, you should be able to get an initial price of 5% or may be more against an unstable currency like yen or the mark. After that, the most significant decision that you need to make is to hedge or not. If you decide not to hedge then it will let the buyer to dollar price swings that are generally 20% in six months. Majority of the companies don’t accept such type of uncertainty.
After this you need to decide upon a hedging strategy. You can choose the hedging strategy based on various statistical analyses of credible results. By choosing a hedge strategy for long time will help you save 3.6 percent as compared to pay without hedging and 1.8% compared to hedging with forwards. Buying in supplier’s currency without hedging is involves a lot of risk and buying in dollars is more risky. So you can choose from hedging with forwards or options. You can choose options if they free as they allow you to take benefit of the stronger dollar and will guard you against weaker dollar. But options are rarely available for free and they are quite costly if you buy them as compared to forwards.
If you try to examine closely the chances of the currency changes and think that the dollar will weaken then you should opt for forward contracts. They will give you the same outcome like an option but at lesser cost. Select on the basis of related cost if there is no clear trend. Options could be a better option then forwards when the dollar had no net change against the yen. Consider purchasing an option if the cost difference between option and forward contract is less than 3.5%
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