Definition
Hedging Forex Risk
Hedging forex risk means using forwards, futures, options or swaps to lock in or limit the exchange-rate cost of future foreign-currency cash flows.
An Indian IT exporter billing in dollars faces rupee appreciation risk; it can book forwards or buy USDINR puts to protect its rupee realisation. An importer paying dollars hedges depreciation risk by booking forwards or buying calls.
The RBI's framework lets corporates hedge underlying exposures through authorised dealer banks and the NSE's currency derivatives. The trade-off is cost (forward premium or option premium) versus certainty; many firms hedge a portion and leave the rest open based on their risk appetite.
Related terms
- Forward Premium / DiscountA currency trades at a forward premium when its forward rate is higher than spot, and at a discount when lower, driven mainly by the interest rate gap between the two countries.
- Currency Swap (FX Swap)An FX swap is a simultaneous agreement to buy a currency at the spot rate and sell it back at a forward rate (or vice versa), used to manage short-term funding and liquidity.
- Currency Futures on NSECurrency futures on the NSE are standardised, exchange-traded contracts to buy or sell a fixed amount of foreign currency against the rupee on a future date.
- Natural HedgeA natural hedge offsets currency risk through the structure of a business itself, such as matching foreign-currency revenues with foreign-currency costs, rather than using derivatives.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.