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Are your business, your projects or your assets exposed to interest rate fluctuations ?

ESTER's experts can advise you on the most appropriate hedging strategies.

Why hedge foreign exchange risk?


When a company incurs costs in a foreign currency, or sells part of its production in a foreign currency, these currency exposures can affect its financial performance. Likewise, an investor who decides to invest in an asset in a foreign currency will see the value of that asset in its own currency vary according to changes in foreign exchanges parities. 

 

To limit the impact of changes in exchange rates, the company or investor can take out a currency hedging contract, which acts as a form of insurance against adverse movements in exchange rates.   

How is foreign exchange rate risk hedged?

It is essential to determine the hedging structure best suited to the company's objectives and constraints, as well as to the specifics of the underlying market. Flows in foreign currency whose amount is certain will not be hedged in the same way as uncertain flows. Similarly, depending on the company's capacity - and appetite - to withstand the impact of foreign rate fluctuations, the most appropriate hedging solution will differ. 

 

Several types of financial contract are used to hedge foreign exchange risk, the most common of which are forward foreign exchange contracts or foreign exchange forwards, whether firm or contingent, foreign exchange swaps, currency swaps, and foreign exchange options or combinations of foreign exchange options such as foreign exchange collars

What is a forward FX transaction?

A forward foreign exchange transaction involves swapping with a counterparty a flow in one currency for a flow in another currency at a future date that is further than two business days away.


The forward exchange rate is agreed at the start, on D.The forward exchange rate is not a market forecast in the sense of an economist’s forecast: it derives from the spot price and the cost/benefit of carrying each currency for the duration of the term.

FX
swap
Cross-currency swap

The challenges of hedging foreign exchange risk

While foreign exchange hedging of commercial flows is standardised and very well mastered, the hedging of net assets in foreign currencies is a more complex subject where situations are much more varied and practices much more diversified, in particular when the change in value of these assets is uncertain. 

 

While it is commonly accepted that debt should, as far as possible, be raised in the currency of the asset to generate a natural hedge by reducing foreign exchange exposure, investment funds, corporates or project finance sponsors are often faced with measuring and managing the foreign exchange risk on equity investment in their foreign currency holdings, assets or projects.

 

The growing exposure of investors to projects in foreign currencies raises questions about the ability to hedge foreign exchange exposure and about best practice in hedging these risks.

 

Our articles on foreign exchange risk
 
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