Posted by forex at 1:30 AM
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1. Hedge with futures or forwards contracts. The predominant way to manage foreign exchange risk is to offset foreign currency holdings or expected revenue with futures or forwards. For example, a company expected to take in a million euros might can sell short a million euros worth of contracts or buy long the equivalent amount in dollars. The net result is that affect on exchange of revenue caused by fluctuation in the currency are canceled out by an opposite position in derivative contracts.
2. Trade options. Just as stocks have puts and calls that trade against their underlying value, currencies also have options. The strategy for hedging a foreign currency position with options is similar to using futures or forwards, but is usually less expensive.
3. Buy swaps. A currency swap is a relatively complex transaction, but an effective method for managing foreign exchange risk. Essentially, it is an exchange of future income streams in different currencies. A company might swap a certain value in a foreign currency to a foreign company who want to sell revenue in dollars. Unlike hedging, though, swaps create a directional bet on the movement of currencies. At the maturation date, the company receiving the currency that has appreciated relative to the other has improved their situation. Thus, a company might use swaps sparingly for portions of their foreign holdings.
4. Open a foreign bank account. Depositing foreign currency in foreign banks and not repatriating it to the home country will not mitigate the effects of currency fluctuations on revenues, the impact of which will appear on financial statements. It will, however, allow the currency to gain a modest interest rate, and in the meantime, if the exchange rate moves and makes the foreign currency more valuable, a future windfall can be realized when the money actually is repatriated.