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Research

Hedging

Hedging

Hedging by definition implies securing your position in a transaction so as you are in a no gain, no loss situation. Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return trade-off. A reduction in risk will always mean a reduction in potential profits as you will have to pay a certain fee to obtain that security. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss.

Currency Hedging are of particular concern to Importers and Exporters due to the change in foreign exchange value of the currencies of each of the parties involved in an overseas transaction. Such unanticipated changes in exchange rate may affect the profitability of a party in a transaction by a considerable amount.

Importer Scenario

For example, an American groceries company which imports wheat from Canada to sell on its local market faces currency risk. Assuming the cost of wheat per metric ton is 300.00 CAD and the home currency of the importer is trading at USD/CAD 1.33350 on 1st January 2016. On that day, the company decides to place an order for 10,000 metric Ton of wheat, but, it will receive the delivery on let's assume 30th March which is the date where the payment must be made amounting to USD 2,250,000.00

Now due to the forces of demand and supply during these 90 days, the value of the Canadian dollar against the US dollar rises to USD/CAD 1.20000, hence the payment on the 30th March will now be USD 2,500,000.00 instead of USD 2,250,000.00. The Groceries Company has to pay USD 250,000.00 more due to Foreign Exchange Fluctuations.

The use of currency hedging could be used as a means to secure your position on a break even basis. At the time of booking the order at an exchange rate of USD/CAD 1.33350 for CAD 300.00 worth of wheat per metric ton, the company must also buy Canadian Dollars of a similar amount of 300.00 in terms of derivatives contracts (CFDs with VIBHS). The company has hedged itself against price fluctuations. In case the Canadian dollar appreciates, the loss made on payment on 30th March will be nullified by the equal gain on the sale of the Canadian CFD contract for USD dollars.

Exporter Scenario

For example, a US company which exports oil to Canada to sell on its local market faces currency risk. Assuming the cost of Brent Crude Oil per barrel is 50 USD and the home currency of the exporter is trading at USD/CAD 1.40000 on 1st June 2016. On that day, the Canadian company decides to place an order for 100,000 barrel of Crude Oil, but, it will receive the delivery on let's assume 31st August which is the date where the payment must be made to the exporter amounting to CAD 7,000,000.00; i.e. USD 5,000,000.00

Now due to the forces of demand and supply during these 90 days, the value of the Canadian dollar against the US dollar falls to USD/CAD 1.60000, hence the payment the US company will receive on the 31st August will now be USD 4,375,000.00 instead of USD 5,000,000.00. The US Exporting Company will receive USD 625,000.00 less due to Foreign Exchange Fluctuations.

The use of currency hedging could be used as a means to secure your position on a break even basis. At the time of booking the order at an exchange rate of USD/CAD 1.40000 for CAD 70.00 worth of Crude Oil per barrel, the company must also buy US Dollars of a similar amount at the same rate of USD/CAD 1.40000 in terms of derivatives contracts (CFDs with VIBHS). The company has hedged itself against price fluctuations. In case the Canadian dollar depreciates, the loss made on the receipt of the payment on 31st August will be nullified by the equal gain on the sale of the US Dollar CFD contract for Canadian dollars.

Hedging can be compared to an Insurance Premium that is paid to get yourself insured, here the premium is replaced by the commission paid to enter the CFD contracts. Currency Hedging with VIBHS Financials allows Importers and Exporters to tailor their hedges to their needs thus mitigating their foreign exchange rate risk.

How to hedge your money against currency risks right now?

To start hedging, open a trading account with VIBHS which provides online services for currency trading on Forex.

If you wish to make your company's money flow predictable and have a clear idea of the volume and period of your goods' realization, then our specialists can open positions on the currency market for you; this will help you to avoid financial losses. If you have any questions related to hedging, please email us at support@vibhsfinancials.mu. Even if you have never hedged your assets before, we will clearly explain how to do it and develop the most appropriate hedging schemes for your business.