Posted by forex at 4:52 AM
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1. Identify expected business transactions. Exporters and investors considering selling foreign investments receive foreign currency; importers and borrowers repaying foreign debt need to purchase foreign currency. A fall in the value of the foreign currency hurts exporters and investors; a rise in the value of the foreign currency undermines importers and borrowers. Since different business transactions have different foreign exchange risk implications, their potential risks have to be dealt with accordingly.
2. Enter into a forward contract. The foreign exchange forward market is not a physical marketplace like a futures exchange but rather a network of business associations in which forward contracts are entered into and exited from by traders, brokers, hedgers and speculators.Banks have been trading foreign currencies for more than a century and are the biggest market participants, according to information from the Federal Reserve Bank of New York. Based on future foreign currency needs for their business, customers would enter into a forward contract with their bank to either buy or sell a foreign currency at a future date but for an agreed-upon rate today--the forward rate.
3. Execute the forward contract. The forward contract is executed when the hedging party has received or is ready to make foreign currency payments on the business side. Any unfavorable rate change up to the currency delivery time as specified in the forward contract is being offset using the predetermined forward rate. But the hedging part also forgoes any favorable change for a certainty in the foreign currency's value, which helps better manage business transactions.