Frequently Asked Questions
What is foreign currency hedging?
A foreign exchange hedge is a method used by companies to eliminate their foreign exchange risk resulting from transactions in foreign currencies.
For example: A French factory’s monthly expenses amount to 1 million Euro per month, with monthly sales of 1.1 million USD. At the Euro/Dollar exchange rate of 1.10, the factory exchanges $1.1 million to €1 million and covers its expenses.
But currency rates change every day. If the Euro/Dollar rate changes to 1.05, the factory now receives €954,545 for $1.1 million and is now roughly €45,500 short.
Foreign exchange hedge protects business from these fluctuations. By applying a hedging strategy, businesses can guarantee a fixed exchange rate between two currencies.
Is there a cost for hedging?
Similar to buying insurance, there is premium for guaranteeing an exchange rate. Depending on the currencies and rates, this cost varies. Zero-cost hedging is possible but carries a risk and the expression ‘there is no free lunch’ is highly applicable in this case
Who do businesses pay to hedge currency?
Businesses deal (via consultants or directly) with banks to conduct foreign currency hedging deals.
What are currency hedging consultants?
Currency hedging consults provide strategies and tactics for eliminating foreign exchange risk. Their goal is to eliminate risk at the lowest cost. Good consultants:
1. Plan according to the business’ upcoming currency flows
2. Design the most appropriate hedging strategy
3. Negotiate with banks for better buy/sell spreads.