Five Reasons Why You Should Use Exchange-Traded Currency Futures for Hedging?

Five Reasons Why You Should Use Exchange-Traded Currency Futures for Hedging?

Foreign exchange market is undoubtedly one of the most liquid and volatile financial markets where currency prices change continuously, thus exercising an important influence on world economy and shaping the fortunes of numerous businesses across the world. However, import and export businesses are especially affected by these currency price fluctuations. Any unfavorable change in foreign exchange or forex rates can lead to prospective losses for importers and exporters and to safeguard against it, currency hedging is often employed.

When a business deal for import or export of goods is finalized, the date of sending the shipment and receiving the payment are also decided. Any changes in the currency prices in the meantime can bring in losses or gains for the businesses involved. For an importer, depreciation in the local currency would be unfavorable and appreciation would be beneficial as he would have to pay lesser amount in local currency. To protect against losses due to possible depreciation in the value of currency, an importer can buy futures contracts for the prevailing forex rates and sell futures contracts at the time of making the payment.

On the other hand, an exporter would benefit from depreciation in the currency and can face losses due to appreciation in the local currency. They need to take measure against possible appreciation in the value of currency to avoid losses. To achieve this, exporters can sell futures contracts at the prevailing forex rates and buy futures contracts for the same amount after receiving the final payment to neutralize any losses incurred due to change in forex rates.

It is also important to note that dealing in exchange-traded currency futures market is far more cost-effective and efficient as compared with over-the-counter (OTC) interbank foreign exchange market. There are several advantages afforded by exchange-traded currency futures over interbank forex market which include:

  1. Lower Cost
  2. Smaller Lot Size
  3. Lower Margins
  4. Higher Liquidity
  5. Better Price Transparency

This price transparency has been made possible due to uniformity in exchange prices for any currency pair. On the whole, dealing in forex through banks can cost around 5 times higher as compared to exchange-traded currency. These are some of the reasons it is highly recommended to go for exchange-traded currency futures to hedge instead of interbank forex market.