www.finpipe.com/hedge.htm).

Currency Swaps

According to our text, “a currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates (Hill, 2002). Here is an example of a currency swap. The organization I work for purchases some of the components of its video units from Germany; it later sells completed video systems in Germany. In order to pay for the supplies, the company has to purchase a sizable amount of Euros. However after a short period the company will receive Euros from the import company which can then be converted to dollars for use in the U.S.

Advantages and Disadvantages of Currency Hedging

Some companies hedge to become or remain competitive. These companies are trying to stay ahead of their competitors that may be located in other countries and that produce similar products which they sale globally.

When a company is able to reduce the amount of foreign exchange risks, it can increase its bottom line by positioning the company so that it is not affected negatively by the change in currency rates. One can not predict the currency rate movement. It is something that changes from day to day. When a company decides to cash its foreign currency into dollars at the right time, it can end up with more money than it started with.

Hedging does not come without a price, hedge prices can raise when the foreign exchange dealers become worried about the risks associated with selling forward contracts. Some will demand a high premium from companies in exchange for a forward exchange contract. Sometimes the cost of hedging can cost a company millions of dollars versus just a few hundred thousand.

The best option for a company when hedging would be to weigh the options and recognize the risks and try to minimize the risks while at the same time increasing the company’s bottom line. The company will want to position itself so it is not affected by the change in the exchange rate. A company must understand the risks involved in hedging and determine what the risks of hedging could be. Some risks could be transaction exposure and economic exposure. In addition to knowing these risks, a company must research and understand why the exchange rates are what they are. The information can be obtained by researching the growth of a country’s money supply, the country’s inflation rate and the interest rates. As with any transaction involving the company’s funds, precautions must be taken to ensure this step will benefit the company in the long run or that the amount of risk is small compared to the risks.

References

Hill, C. (2002). International Business Competing in the Global Market Place (4th ed.). New York: McGraw-Hill/Irwin.

Exchange Rates Retrieved February

www.econ.armstrong.edu/saadatmand/FER.htm

Briggs, P. (2004, December). Currency hedging by exporters and importers.

What is hedging? Why do companies hedge? Retrieved February