Exposure management is critical for multinational corporations or businesses involved with exporting or importing goods. Techniques for exposure management minimize the risks associated with currency fluctuations when converting currencies. Businesses should carefully consider each available option when encountering a situation requiring exposure management, as there is not one best technique for minimizing exposure risk.
A futures contract is useful to provide limited exposure to risk by allowing the business to either purchase or sell a contract representing the currency and amount needed at a specified exchange rate. For example, if your company is purchasing products by using euros 60 days from today, there is no way of knowing if the euro will be stronger against your home currency, which would make the products more expensive than anticipated. The forward contract allows you to purchase the euros at today’s price but 60 days from today. A disadvantage is that if your home currency becomes stronger, you can not take advantage of the exchange rate because you already have agreed upon a specified rate.
A forward hedge is similar to the futures contract, yet you can negotiate the rate directly with the bank or financial institution. A futures contract is a standard contract that can be purchased or sold on the exchange market, whereas a forward hedge is a customized solution for your business in particular.
An option gives you the right to exchange the currency at a specified rate, but not the obligation to do so. Consider an option as a type of insurance policy for a specified time period, where you pay for the option to make the trade in case the need arises where it would prove useful.
- "International Financial Management"; Jeff Madura; 2009
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