Hedging in Foreign Exchange

Today, we will learn an important term of finance. Its name is hedging in foreign exchange market. It is totally different from hedge fund. Hedging in foreign exchange market means to reduce the risk of loss in forex market. I persuade this by taking a very simple examples.


Ist Example

Suppose, you have opened your online forex account in SBI. You are A and you buy one dollar when its price was Rs. 45 and you bought it on its future price Rs. 47. Suppose, if the value of $ will depreciate and value of Rupees appreciates. At that time, you will face loss Rs. 2  in this future contract of currency exchange. For reducing this loss, you can do an opposite contract in forex market. You do the contract of sale. You can agree to sell the 1 $ in Rs. 44 in future. If value of dollar moves to Rs. 44 instead of Rs. 47, you will loss Rs. 1 in buying contract but get profit of Rs. 1 in selling contact. Automatically, your overall loss will nil or be minimum.



2nd Example

For example, Rupee(USD/INR),one month is trading at Rs.47 and if one feels that Rupee would depreciate to Rs.49, he can enter into a ‘long’ position, by ‘buying’ a currency futures contract. If USD/INR for the same maturity period goes to Rs.49, he makes a gain of Rs.2 per dollar. So on a single contract of 10000$, he makes a gain of Rs.2000. But, if USD/ INR for the same maturity goes to Rs. 45, he loses Rs. 20000. So, it is big risk, if you have invested big amount. So, for reducing this risk of loss, he can also do hedging contract in foreign exchange market. He can do "selling" the contact with "buying" contract.

If the Rupee one month is trading at Rs.47 now and expects it to move to Rs.45, he can enter into a ‘short’ position by ‘selling’ a currency futures contract. If USD/INR rate for the same maturity period moves to Rs.46 he makes a gain of Rs.2 per dollar, on squaring off his position. He makes a gain of Rs.20000 on this contract. If we adjust his loss of Rs. 20000 of his buying contract with his profit of Rs. 20000 in selling contract, you will get nil loss. So, investors should use hedging for safeguarding his money from loss in forex market.

Related : List of Hedge Funds in India

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Accounting Education: Hedging in Foreign Exchange
Hedging in Foreign Exchange
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