Question

Essay type question: Discuss the techniques that a company might use to hedge against the foreign exchange risk involved in foreign trade. Discuss the factors that may persuades a company to hedge an interest rate exposure by using Over-the-Counter (OTC) options rather than exchange traded interest rate futures contracts.

Answer 1

Ans. The techniques that a company might use to hede against the foreign exchange risk involved in foreign trade are

1) Currency forwards: For hedging purpose ,the company can buy currency forwards which will be beneficial for them if their local currency( in which they finally want the amount from trade) appreciates too much with regard to the foreign currency.

2)Currency options: They can buy currency options which give them the right to exchange currency at a particular strike price before the expiration date.

3) Currency futures: They can be easily bought through an exachange and it only requires a very small margin.

The main factor that will persuade the company to hede interest rate exposure by using OTC options rather than ET interest rate futures contract is that the futures contract is settled daily and the gain and loss is credited or debited from the account daily.