Currency risk hedging

Companies dealing with foreign currencies are exposed to currency exchange rate risk which means they may get financial gain or loss from changes in exchange rates. Currency exchange risk also makes company’s cash flows unpredictable and therefore difficult to plan. Currency exchange risk can be managed by “on-balance sheet” hedging: for example a company may agree with its Swedish partner to make transactions in euro instead of Swedish krona, but this requires consent from both sides which usually is not easy to achieve. Alternatively, financial instruments can be used to hedge currency exchange rate risk.

Most common financial instruments

  • Currency Exchange Forward - an agreement between two counterparties to exchange a specific amount of one currency to another on a specific future date at the agreed exchange rate.
  • Currency Exchange Swap - an agreement to borrow one currency against the other for an agreed term.
  • Currency Exchange Option - an agreement which gives the right (but not an obligation), to exchange a specific amount of one currency to another on a specific future date at the agreed exchange rate.
  • Structured Deal - an agreement consisting of several financial instruments to hedge currency exchange risk customised for company’s specific needs.

Example

Log houses producer company sells its houses to Swedish buyer. The buyer pays to the producer in 6 months’ time in SEK, therefore producer is exposed to a risk that after 6 months SEK has weakened. Weaker SEK means lower profit margin for the producer. To hedge against possible weaker SEK the producer concludes a Currency Exchange Forward to fix the exchange rate for selling SEK in 6 months’ time.

Swedbank offers variety of financial instruments for many currencies. In order to find the best solution please contact Swedbank Markets specialists.

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