Financial Management
Hedging Interest Rate using Smoothing When taking out a loan or depositing money, businesses will often have a choice of variable or fixed rates of interest. Variable rates are sometimes known as floating rates and they are usually set with reference to a benchmark such as LIBOR, the London Interbank Offered Rate. For example, variable rate might be set at
Continue reading Hedging foreign currency loan using currency swap A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate. During the length of the swap
Continue reading Hedging Exchange Rate | Currency risk using Options Options are radically different. They give the holder the right, but not the obligation, to buy or sell a given amount of currency at a fixed exchange rate (the exercise price) in the future (if you remember, forward contracts were binding). The right to sell a currency at a set rate is
Continue reading Hedging Exchange Rate | Currency risk using Currency futures Simply think of these as items you can buy and sell on the futures market and whose price will closely follow the exchange rate. Let’s say that a US exporter is expecting to receive €5m in three months’ time and that the current exchange rate is US$/€1.24. Assume that this rate
Continue reading Hedging Exchange Rate | Currency risk using Money market hedging Let’s say that you were a UK manufacturer exporting to the US and in three months you are due to receive US$2m. You would suffer no currency risk if that US$2m could be used then to settle a US$2m liability; that would be matching the currency inflow and outflow. However,
Continue reading Hedging Exchange Rate | Currency risk using Forward exchange contracts A forward exchange contract is a binding agreement to sell (deliver) or buy an agreed amount of currency at a specified time in the future at an agreed exchange rate (the forward rate). In practice there are various ways in which the relationship between a current exchange rate (spot rate)
Continue reading Hedging Exchange Rate | Currency risk using Leading and lagging Let’s imagine you are planning to go to Spain and you believe that the euro will strengthen against your own currency. It might be wise for you to change your spending money into euros now. That would be ‘leading’ because you are changing your money in advance of when you
Continue reading Hedging Exchange Rate | Currency risk using Matching If you have a sales transaction with one foreign customer, and then a purchase transaction with another (but both parties operate with the same foreign currency) then this can be efficiently dealt with by opening a foreign currency bank account. For example: 1 November: should receive US$2m from US customer 15 November:
Continue reading Hedging Exchange Rate | Currency risk using Netting If you owe your Japanese supplier ¥1m, and another Japanese company owes your Japanese subsidiary ¥1.1m, then by netting off group currency flows your net exposure is only for ¥0.1m. This will really only work effectively when there are many sales and purchases in the foreign currency. It would not be feasible
Continue reading Hedging currency/Exchange Rate risk using own currency invoice Arrange for the contract and the invoice to be in your own currency. This will shift all exchange risk from you onto the other party. Of course, who bears the risk will be a matter of negotiation, along with price and other payment terms. If you are very keen to get a
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