Hedging currency risks: how to protect money

Hedging currency risks is a set of measures and operations conducted with derivatives market instruments, which include options, futures, forwards, aimed at reducing the impact on the company's performance of end risks. When banks insure foreign exchange risks, the hedged asset is the currency planned for purchase or available.

In times of crisis, the risks of companies that conduct business in various spheres of the economy are several times higher. At the same time, the financial sector is particularly likely to receive losses or shortfall in profits. Therefore, it is appropriate to hedge the currency risk.

In itself, the concept of risk means the occurrence of adverse events or their consequences, which lead to indirect damage or to direct losses. The most significant are the currency, investment and credit risks. They not only lead to serious deterioration of the company's financial climate, but can eventually lead to bankruptcy or loss of capital.

The pressure is primarily on currency risks, which are the likelihood of negative consequences from the change in the exchange rate of the foreign currency to the national currency or from changes in the volume of income received abroad during conversion. These risks, first of all, are related to the diversification of the activities of banks and the internationalization of operations conducted in these institutions.

It should be noted that the change in exchange rates is influenced by numerous factors. This includes, for example, the psychological factor that manifests itself in the confidence in the currency of non-residents and domestic companies, the regular flow of money from one country to another, and, finally, speculative operations. To avoid or reduce losses in this situation, hedge currency risks.

Significant impact on the change in the exchange rate of the national monetary unit is the actions of the Central Banks of countries with whose currencies the investor operates. For exchange rates this factor is the most important.

Strengthening of such risks forces financial institutions and, first of all, banks to the necessity of minimizing the negative effects by insurance or by hedging currency risks.

When insuring long-term currency risks, swaps are used that represent a combination of forward and forward cash transactions. In essence, this is the combination of conversion counter currency transactions for the same amount with different value dates. This hedging of currency risks is especially convenient for banks, as the result does not form uncovered currency positions, since the volumes of liabilities of banks and claims in foreign currency coincide. As a result, it turns out that swaps provide an opportunity to exchange risks for participants in the financial market, paying off the most unfavorable effects at the same time.

The use of such transactions is necessary when, when concluding long-term forward contracts , difficulties arise because of the bank's concerns that the other party to the contract will not fulfill its terms before the contract expires.

Hedging of currency risks: a variety of swaps

The first type is similar to the appearance of a counter loan, in cases where banks provide loans denominated in various currencies with approximate or identical maturities.

In the second variant, an agreement is concluded between two banks on the sale or purchase of currency at the spot rate. The transaction is carried out in the future or at a predetermined time.

It should be noted that hedging currency risks in the case of a competently constructed scheme will not only protect the company, but also in the long run will provide additional profit.