Types of Foreign Currency Hedging Vehicles

Using foreign currency hedging vehicles can be a good way to deal with the risk that comes with making transactions in a foreign currency. When a business engages in transactions with a foreign party, there is a certain amount of risk that comes with the foreign currency exchange. The use of a currency hedging vehicle can mitigate this risk. Here are a few of the different types of foreign currency hedging vehicles that you can use to deal with risk.

Spot Contracts

A spot contract is a type of contract in which you agree to buy or sell a specific amount of foreign currency at the current exchange rate in the market. When you do this, you are giving yourself up to two days to settle the transaction. This is considered a very short term fix for dealing with foreign currencies. You have only two days to complete the transaction, but it does lock in the exchange rate.

Forward Contracts

Another type of foreign currency hedging vehicle is a forward contract. With this type of contract, you agree to buy or sell a certain amount of a foreign currency at a specific price at a future date. This is similar to a spot contract except that you agree on the price and you also have more time to complete the transaction. This is a little more ideal for instances when you need some more time to work.

Foreign Currency Options

A foreign currency option allows you to buy or sell a specific amount of foreign currency at a strike price on or before a specific date that is agreed upon by both parties. You have to pay option money to the other party in order to secure this type of contract. If you decide not to fulfill the contract, the other party gets to keep the option premium. This contract gives you the right to buy or sell, but you do not have to if you decide not to.

Interest Rate Options

With interest rate options, you are essentially engaging in the same type of contract as with a foreign currency option. You pay a premium to the other individual to secure the option. The only difference is that you are trading an interest rate contract instead of a foreign currency.

Foreign Currency Swaps

With a foreign currency swap, you agree to trade an equal amount of foreign currencies with another party at the current exchange rate in the market. Then, at the end of the transaction, you trade back so that you can have your original domestic currency.

Interest Rate Swaps

With this type of contract, you agree to swap interest rate contracts with another party. In most cases, you will exchange a floating rate for a fixed rate with the other party. In some cases, you will trade a fixed rate and receive a fixed rate. You can also trade a floating rate for a floating rate.