What are the different types of foreign currency hedging vehicles?
There are three basic vehicles, although there are variations upon these three. The first type is a spot transaction, which is the immediate buying or selling of one currency for another. Using the market price today, settlement usually takes place within two business days. A company that only transacts using spot trades is typically accepting the most risk. The second vehicle is a forward contract. The price is locked in immediately, but settles on a date in the future. Monies do not change hand until that stipulated future date. Theoretically, the forward price can be the same as the spot price; however, the forward price, based on interest rate differentials, is usually either higher (premium) or lower (discount) than the spot price. Finally, there are option contracts that provide the company the right, but not the obligation, to purchase or sell a specific amount of foreign currency for a specific date in the future. For this right, the purchaser of the option pays a premium which
There are three basic vehicles, although there are variations upon these three. The first type is a spot transaction, which is the immediate buying or selling of one currency for another. Using the market price today, settlement usually takes place within two business days. A company that only transacts using spot trades is typically accepting the most risk. The second vehicle is a forward contract. The price is locked in immediately, but settles on a date in the future. Monies do not change hand until that stipulated future date. Theoretically, the forward price can be the same as the spot price; however, the forward price, based on interest rate differentials, is usually either higher (premium) or lower (discount) than the spot price. Finally, there are option contracts that provide the company the right, but not the obligation, to purchase or sell a specific amount of foreign currency for a specific date in the future. For this right, the purchaser of the option pays a premium which
