Currency risk means the possibility of loss or profit caused by the variation in the exchange rate of different currencies and emerges when a sale and purchase transaction is invoiced or financed in a currency other than the national one. To protect their commercial margins, companies can resort to hedging instruments. Making the right decision implies previously determining the current and future global risk position of our company, evaluating the impact of the different trading scenarios and selecting the most appropriate instrument.
These are the most used instruments:
- Exchange rate insurance: Hedging transaction whereby a financial institution undertakes to sell to or buy a certain type and amount of currency from a company, in exchange for another amount and type of currency, on a previously agreed future date and at a price (exchange rate) fixed in advance. The parties must comply with their respective obligations at maturity, in any case the agreed currency should be exchanged at the originally agreed exchange rate, regardless of the price at which these currencies are quoted in the markets on the expiration date. Basic characteristics:
- Settlement periods of less than 1 year.They can be cancelled for part or for the total amount of the sale and purchase transaction.They can be taken out from the moment the sale and purchase transaction is closed or at any time prior to the collection or payment date.
- There are different types of exchange rate insurance such as weighted average exchange rate insurance or flexible exchange rate insurance.
- Currency option: Hedging transaction by which the company acquires, by paying a premium in advance, the right to buy (call option) or to sell (put option) to a financial institution any currency at a previously agreed exchange rate (strike) and for a specified period. If the right can be exercised throughout this period, it is called an American option and, if it must be exercised on a fixed date, it is called a European option.
