This lesson covers the practical strategies treasurers use to manage FX risk, from internal techniques to external hedging instruments.

3.1. Internal Hedging Techniques

Internal hedging techniques are strategies used within the company to reduce FX exposure without using external financial instruments . These include:

  • Currency of Invoice: Invoicing a foreign customer in the company’s own domestic currency passes the risk to the customer .

  • Matching Receipts and Payments: Offsetting foreign currency receipts against payments in the same currency .

  • Matching Assets and Liabilities: Offsetting foreign currency assets with foreign currency liabilities .

  • Leading and Lagging: Adjusting the timing of payments and receipts to take advantage of expected exchange rate movements .

  • Netting: Offsetting intercompany payables and receivables to reduce the number of cross-border transactions and minimise FX exposure .

3.2. External Hedging with Derivatives

When internal hedging is insufficient, treasuries use external financial instruments . The key derivative instruments are:

  • Forward Exchange Contracts: An agreement to exchange a specified amount of one currency for another at a fixed rate on a future date . This is the most common hedging tool for locking in an exchange rate.

  • Money Market Hedging: Borrowing in one currency, converting it to another, and putting it on deposit until the transaction is completed .

  • Currency Futures: Exchange-traded, standardised contracts to buy or sell a currency . They offer advantages in liquidity and credit risk management.

  • Currency Options: Contracts that give the holder the right, but not the obligation, to buy (call) or sell (put) a currency at a specific rate on a future date . They offer flexibility but require payment of a premium.

PreviousNext