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Increase your knowledge about trading and make profit from the market. A foreign currency hedge is placed when a trader enters the foreign currency market with the specific intent of protecting existing or anticipated physical market exposure from an adverse move in foreign currency rates. Banks who deal internationally have inherent risk exposure to foreign currencies, often in multiple ways including trading vehicles. Placing a currency hedge can help to manage foreign exchange rate risk. Both large and small commercial entities who conduct international business also have risk exposure to foreign currencies. Selling in foreign currencies and accepting foreign exchange rate risk are often a function of day-to-day business and can help commercials stay competitive.
Retail foreign currency traders use foreign currency hedging to protect open positions against adverse moves in foreign currency rates. International commerce has rapidly increased as the internet has provided a new and more transparent marketplace for individuals and entities alike to conduct international business and trading activities. Significant changes in the international economic and political landscape have led to uncertainty regarding the direction of foreign exchange rates. Interest rate exposure refers to the interest rate differential between the two countries’ currencies in a foreign exchange contract. The interest rate differential is also roughly equal to the “carry” cost paid to hedge a forward or futures contract. As a side note, arbitragers are investors that take advantage when interest rate differentials between the foreign exchange spot rate and either the forward or futures contract are either too high or too low. Investing in foreign stocks automatically exposes the investor to foreign exchange rate risk and speculative risk.
Foreign currency traders utilize foreign exchange hedging to protect open positions against adverse moves in foreign exchange rates, and placing a foreign exchange hedge can help to manage foreign exchange rate risk. Speculative positions can be hedged via a number of foreign exchange hedging vehicles that can be used either alone or in combination to create entirely new foreign exchange hedging strategies. Below are some of the most common types of foreign currency hedging vehicles used in today’s markets as a foreign currency hedge. Retail forex traders typically use foreign currency options as a forex hedging vehicle. Banks and commercials are more likely to use forwards, options, swaps, swaptions and other more complex derivatives to meet their specific forex hedging needs.