A hedge of currency risks is a set of measures and operations carried out with derivatives market instruments , which include options, futures, forwards, aimed at reducing the impact on the company's performance of ultimate risks. When banks insure currency risks, the hedged asset is the currency planned for purchase or available.
In a crisis, the risks of companies doing business in various sectors of the economy increase significantly. At the same time, in the financial sector, the probability of loss or loss of profit is particularly increased. Thus, it is appropriate to hedge currency risk.
The concept of risk itself means the occurrence of adverse events or their consequences, which lead to indirect damage or direct losses. The most significant are currency, investment and credit risks. They not only lead to serious deterioration of the financial climate of the company, but also in the end can cause bankruptcy or loss of capital.
The pressure is primarily on currency risks, which are the likelihood of negative consequences from a change in the exchange rate of a foreign currency to a national currency or from a change in the amount of income received abroad during conversion. These risks are primarily associated with the diversification of banks and the internationalization of operations carried out in these institutions.
It should be noted that many factors influence the change in exchange rates. This, for example, includes the psychological factor, which manifests itself in confidence in the currency of non-residents and domestic companies, regular overflow of cash flows from one country to another, and, finally, speculative operations. To avoid or reduce losses in this situation, hedge currency risks.
A significant impact on the change in the exchange rate of the national currency is exerted by the actions of the central banks of the countries with whose currencies the investor works. For exchange rates, this factor is critical.
The intensification of such risks forces financial institutions and, first of all, banks to the necessity of minimizing negative effects by insurance or by hedging currency risks.
When insuring long-term currency risks, they use swaps that represent a combination of forward forward transactions and cash spot. Essentially, this is a combination of conversion opposite currency transactions for the same amount with different value dates. This hedging of currency risks is especially convenient for banks, since the result is not formed uncovered currency positions, as the volumes of banks' liabilities and claims in foreign currency coincide. As a result, it turns out that swaps provide an opportunity to share risks with financial market participants, while paying off the most adverse effects.
The use of such transactions is necessary when it is difficult to conclude long-term forward contracts due to fears of the bank that the other side of the contract will not fulfill its conditions before the contract expires.
Currency Risk Hedging: Swap Types
The first type is similar to processing a counter loan, in cases where banks provide loans denominated in different currencies with approximate or equal repayment periods.
In the second option, an agreement is concluded between the two banks on the sale or purchase of currency at a spot rate. The transaction is carried out in the future or at a predetermined time.
It should be noted that a hedge of currency risks in the case of a well-constructed scheme will not only protect the company, but also in the long term will provide additional profit.