Most organisations that do business internationally either via the export of goods & services or via the import of the same understand the need to hedge foreign exchange risk. An adverse price movement in the currency pair could significantly impact the profitability of a contract.
At prosperity wealth management we provide various tools to business owners to mitigate their foreign exchange risk and factor in the cost of hedging into their product cost. We predominantly use derivate contracts such as options, forwards and range forwards to hedge forex risk depending upon the suitability of the same.
Buying an options contract gives the buyer the right but not the obligation to execute the contract at predetermined price (also known as the strike price) during its term. An options strategy completely protects the buyer from any losses due to adverse price movements while giving him the freedom to exploit any favourable changes in the currency pair. This of course comes at a cost called the ‘premium’ which the buyer has to pay to the seller for purchasing the contract. (See example)
A much more cost-effective way to hedge forex risk is for an exporter or importer to buy or sell a forward contract at a predetermined price. This locked-in price could be availed in the future upon the expiry of the contract. Though this approach is significantly cheaper it does not allow the exporter or importer to exploit any favourable changes in the price movements upon the expiry of the contract (See example)
Range forwards are a combination of two option contracts where one contract is purchased by the buyer and the other contract is simultaneously sold in the market. This cancels out the cost involved as the buyer both receives and pays the premium to hedge his risk. The buyer in this case is able to benefit from a favourable movement in the prices without having to bear the burden of paying a premium.
To understand better how we could help you hedge your foreign exchange risk, get in touch with us here.