Hedging and Forward Contracts- Forward contracts are a type of hedging product. They allow a business to protect itself from currency market volatility by fixing the rate of an exchange over a set period on a pre-determined volume of currency. There are two different types of forwarding contracts. Closed forward contract.
Hedging is securing against loss from various risks that take place in international financial markets. This applies to several methods to counteract the risks that are come across. Hedging also means to alter the formation of assets and liabilities to offset exposure to the exchange risk. By matching their assets and liabilities in foreign currencies, hedgers avoid exchange risk. Using different hedging techniques is a way by using which a bank eliminates or minimizes its risk exposure. Hedging is done in the following ways,
Foreign Currency Assets & Liabilities Matches: A commercial bank matches its assets and liabilities in foreign currencies to ensure a profitable spread by dealing in foreign exchange. This technique ensures the positive profit spread no matter what the movements in the exchange rate are at the respective maturities of these assets and liabilities.
Hedging using Derivatives: A commercial bank uses foreign currency derivatives to hedge foreign exchange risk. Foreign currency derivatives are of the types:
- Foreign Currency Futures
- Foreign Currency Swap
- Foreign Currency Options
- Foreign Currency Forward Contracts
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