How Hedging Can Reduce Currency Risk When Conducting Business Overseas

How Hedging Can Reduce Currency Risk When Conducting Business Overseas

The term “hedging” refers to an array of strategies used to reduce risk when conducting international business. The practice seeks to minimize the consequences of negative market movements, allowing companies to establish more reliable estimates of revenue.

However, hedging is a concept that can often seem confusing. It’s not a way of increasing the amount of money made. It is a strategy in place purely to help decrease risk and reduce possible losses as a result.

Here’s how hedging can help minimize foreign exchange (FOREX) risk, especially regarding business overseas.

Hedging International Business FOREX Risk: Popular Methods

Hedging is a relatively broad term, referring to multiple methods. Thus, there are no specific mechanisms in place for every hedging operation.

However, there are specific methods used more commonly than others to achieve the best results.

Debt Operations

This method focuses on borrowing currency. Investors borrow foreign currency based on the estimated amount they’re expecting to get in the future.

This borrowed amount is converted into their local currency and deposited, therefore, hedging any risk of exchange rate fluctuations. The currency received is used to repay the debt, regardless of whether local interest is enough to cover the interest of the loan. As a result, debt operations can be an expensive option depending on local circumstances.

Forward Contracts

Arguably the most common hedging method, forward exchange contracts are agreements in which investors confirm a current exchange rate for a pre-set future date. This strategy  means their assets are protected from movements, as the rate is pre-determined.

This method is incredibly effective in protecting against negative movements, in which a loss would otherwise occur had the forward contract not been in place. However, this minimizes the effects of positive movements, too.

If exchange rate fluctuations result in a profit, the original pre-set rate will still be received, and no extra money earned.

Get the Best Results with International Business Hedging

Before attempting to hedge FOREX risk, it’s essential to do as much research as possible first. Knowing your chosen market is crucial to minimizing risk effectively.

As there are plenty of available methods, practicing is also equally important. Becoming familiar with your chosen strategy is likely to provide greater reassurance, skill, and results in the long-run.

For more information about hedging risk in international business, get in touch with MKS&H today to speak with a professional business consultant.

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