How to use futures contracts to hedge currency risks?

Diana Cioltei, 27 Mar 2009

Romanian version

The leu devaluation that shook up the market in the past few months has laid bare an aspect that many companies paid no attention to or saw it as still a positive aspect even amid economic downturn – currency risk. The exposures have resulted in severe losses in companies’ annual reports and brought fresh attention on the alternative of hedging the currency risk using derivatives.

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Currency risk management

The need to hedge the currency risks via futures contracts for foreign currency has determined a growing number of companies to use these instruments that developed gradually over the years.

The first step in creating an efficient currency risk management is the identification of the risk posed by a company, which can be transaction, economic or translation, said Cosmin Bucur, director of financial market department at RBS Romania, at the conference organized by Brokers’ Association on currency risk.

The specialist explained that a company should begin by defining the objectives and its policy in fixing the exchange rates in order to secure stability of financial results and to minimize the risk of cash flow.

After the company has defined its objectives, has identified its currency exposure, risk tolerance as well as the purpose of hedging, it is in the position to draft and adopt a strategy.

According to an ISDA (International Swaps and Derivatives Associations), 92% of the world’s 500 biggest companies use derivatives, where 85.1% hedge the risk arising from the interest and 78.2% the currency risk.

“We can see a thirst for predictability among middle and large companies, especially now when the currency risks is growing at an alarming pace because of the crisis”, said Bucur.

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