Exchange Rate Mechanisms Paper - Currency Hedging
Currency hedging involves deliberately taking on a new risk that offsets an existing one, thereby reducing a businesses' exposure to negative change in exchange rates, interest rates, or commodity pricing (Economists.com, n.d.). "Currency hedging allows a business owner to greatly reduce or eliminate the uncertainties attached to any foreign-currency transaction" (Fraser, 2001). It is impossible to predict the how much a currency will be worth on the exact day that a company will be converting it. With hedging, the uncertainly is gone. Many companies that have international operations are constantly juggling multiple transactions, with payments that are staggered and tied to the swing of a number of currencies.
There are a growing number of banks as well as business to business websites that offer currency hedging, regardless of company size. It used to be that the only way to truly avoid the risk of currency fluctuation was to transact all international business in U.S. dollars. For small companies, especially, it would be hard to insist on these terms (Economists.com, n.d.). There are a number of currency hedges, including: spot contract; forward transactions; options; currency swaps; and non-deliverable forwards (Wachovia, n.d.).
Spot contracts are a way of converting currency from another country into U.S. dollars or for making a payment in foreign currency. Currency can be bought at today's exchange rate, and in most cases, the final settlement occurs in two days. Forward transactions are very popular, especially for those just getting into currency hedging. Forward transactions allow a company to buy or sell a currenc...
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..., all international business transactions would be paid in U.S. dollars and there would be no need for currency hedging. Unfortunately, many customers and suppliers will not go along with those terms. Businesses that hope to successfully operate internationally will do well to fully educate themselves relative to the benefits that currency hedging offers.
Economists.com (n.d.). Economics A-Z. Retrieved October 4, 2005, from htto://www.economist.com/research/Economics/alphabetic.cfm?TERM=HEDGE
Fraser, J. A. (2001, March). Follow the big guys. Inc. Magazine, , . Retrieved October 4, 2005, from http://www.inc.com/magazine/20010301/22118.html
Hill, C. (2003). International business: Competing in the global marketplace (3rd ed.). New York: The McGraw-Hill Companies.
Wachovia (n.d.). Currency hedge tools. Retrieved October 3. 2005, from www.wachovia.com
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