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How to Hedge Currency Risk

In: Business and Management

Submitted By JWSHWA
Words 591
Pages 3
How to Hedge Currency Risk
A reliable way to hedge currency risk is to use forex options. This approach works for businesses that need to make purchases with foreign currencies, currency speculators who engage in strategies such as the carry trade and anyone who wants to use a safe haven currency to protect their wealth. How to hedge currency risk is by purchasing calls on the currency that you will or may need to buy with the currency that you have. How does this work?
Forex and Forex Options
There are two kinds of options that one can purchase or sell. These are calls and puts. A call gives the buyer the right to purchase one currency with another at a set price called the strike price. He has a base currency and purchases a call option on the reference currency. The buyer is under no obligation to so and will only execute the options contract and make the purchase if it is profitable to do so. The seller of a call is, however, obligated to sell the base currency and purchase the reference currency if the buyer executes the options contract. The seller receives a premium for taking on this risk.
A put gives the buyer the right to sell one currency for another at a set price called the strike price.
He has a base currency and buys a put option that will allow him to sell the base currency and purchase the reference currency if doing so will make a profit or hedge against loss. The seller of a put contract is obligated to purchase the base currency with the reference when the buyer executes the contract. The seller receives a premium for taking on this risk.
Hedging Risk
Getting hurt by the Forex race to the bottom is a distinct possibility for international businesses. As an example, Japan has been seeking to devalue its currency to make its exports more competitive and to jumpstart its sluggish economy. Let’s say that you are a Japanese airline...

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