Currency risk management techniques include forward hedges, money market hedges, and option hedges.
Hedging techniques usually include the use of complicated financial instruments known as derivatives including options and futures. A forward hedge is an agreement indicating an amount of currency to be obliged at a rate decided on the date of contract.
A forward contract protects the value of the currency that is traded. The optimum value is one at which an
exchange transaction would take place in future.
A currency option allows the holder to buy a or sell a a desired currency at a predetermined exchange rate. These options are executed for a limited time. In other words, these contracts get annulled after the specific period. Currency hedges are very useful in international business. When a citizen of UK buys cars from a US dealer on the basis of foreign currency hedge, the former agrees to buy certain number of cars from the latter at the rate prevailing on the date of buying. The transaction may take place in Pounds as the case may be. The UK importer creates a hedge by buying currency option in US currency, dollar by which he is protected against any fluctuation as a consequence of economic or political or any other change.
Money market hedge are sought to reduce risk in currency trade. This is done by keeping the foreign currency value in domestic currency. For example assume that the forward currency that is receivable is British pounds.