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Currency Hedging

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Submitted By aishwarya12
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Currency Hedging
When companies conduct business across borders, they must deal in foreign currencies. Companies must exchange foreign currencies for home currencies when dealing with receivables, and vice versa for payables. This is done at the current exchange rate between the two countries. Foreign exchange risk is the risk that the exchange rate will change unfavorably before payment is made or received in the currency . For example, if a United States company doing business in Japan is compensated in yen, that company has risk associated with fluctuations in the value of the yen versus the United States dollar.[1]
A hedge is a type of derivative, or a financial instrument, that derives its value from an underlying asset. Hedging is a way for a company to minimize or eliminate foreign exchange risk. Two common hedges are forward contracts and options.
A forward contract will lock in an exchange rate today at which the currency transaction will occur at the future date.[2]
An option sets an exchange rate at which the company may choose to exchange currencies. If the current exchange rate is more favorable, then the company will not exercise this option.[2]
The main difference between the hedge methods is who derives the benefit of a favourable movement in the exchange rate. With a forward contract the other party derives the benefit, while with an option the company retains the benefit by choosing not to exercise the option if the exchange rate moves in its favour.
Accounting for Derivatives[edit]
Under IFRS[edit]
Guidelines for accounting for financial derivatives are given under IFRS 7. Under this standard, “an entity shall group financial instruments into classes that are appropriate to the nature of the information disclosed and that take…...

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