Advantages And Disadvantages Of Hedging

Domestic-currency and hedging give internationally active firms to reduce their exposure to exchange rate variations. Foreign exchange risk arises when the value of the investment fluctuates due to the changes in currency 's exchange rate. When the domestic currency appreciates against a foreign currency, profit or returns earned in the foreign country will decrease after being exchanged back to the domestic currency. Due to the somewhat volatile nature of the exchange rate, it can be quite difficult to protect against this kind of risk, which can harm sales and revenues. In general, organizations engaging in international finance activities can experience much greater uncertainty in their revenues. An unsteady and unpredictable stream of revenue can make it hard to operate a business effectively. Despite these negative exposures, international business can open up opportunities for reduced resource costs and larger lucrative markets. There are also ways in which a company can overcome some of these risk exposures.

For this reason, they are unable to price their products in a way that reflects exchange rate risk exposure, which makes business planning difficult. The key purpose of FX hedging is, therefore, to eliminate the consequences of uncertainties regarding future exchange rate fluctuations.

FX hedging enables both importers and exporters to:

1. make a clear calculation of future cash flows,

2. set prices in a way which ensures business plan implementation,

3. ensure operational stability and focus on their core activity

The main derivatives used in FX hedging are:

1.forex forwards – contracts to buy or sell a particular currency for another at an agreed future date and at an exchange rate agreed in advance;

2.forex swaps – involving simultaneous purchase and sale of two currencies at predetermined exchange rates but at two different value