Technological advancement has stimulated international commerce by providing easy options to the individuals as well as to the business houses. In these circumstances, currency hedging or foreign exchange risk hedging is becoming very important. The reason behind this is that the foreign exchange rates are related to a number of factors and any kind of change in the international political scenario or in the international economic scenario is going to influence the exchange rates instantly. At the same time, currency hedging or foreign exchange risk hedging can also provide assurance for a sound financial position in the future.
Any individual or company involved in any kind of business or trade where the transaction is going to take place in foreign currencies, is exposed to the risk of fluctuating exchange rates. These risks occur when the exchange rate of a particular currency falls. To prevent such losses anyone who is involved in such transactions should have commercial contracts, which would offer a fixed rate of exchange. These contracts act as currency hedging or foreign exchange risk hedging.
At the same time, there are certain investors who are also in need of currency hedging or foreign exchange risk hedging. These investors, may be individuals or organizations, prefer to invest in the foreign financial markets through foreign stocks, bonds and many more. This is done to take advantage of a growing economy and to ensure good returns. At the same time, investment in the foreign markets provides diversity in the investment portfolio that can reduce the risk related to the investment portfolio. But at the same time, there are some other risks also. Now, to invest in any foreign market one has to buy foreign currency against the domestic currency. The currency exchange rates may depreciate in the future. In that case, even if the investor has made good profits from the financial market, he might have to face a loss while converting the profit into domestic currency.
There are several currency hedging or foreign exchange risk hedging tools provided by a number of financial organizations. The foreign currency traders use these tools to minimize the risks related to the process of foreign exchange. These tools can be used individually or jointly. One of these currency hedging or foreign exchange risk hedging instruments is the forward exchange contract. Two parties remain involved in this contract. One party promises to sell a particular currency and the another party promises to buy the same currency at a pre-decided date in the future and the exchange rates are also decided in advance. This contract is very useful because if the exchange rate of that particular currency falls the seller is not going to face any kind of loss and if it rises the buyer is in a safe position.