The Benefits of Hedging, and Managing FX Risk: Part 1

Many small- and medium-sized firms engaging in import and/or export activity tend not to hedge. The reasons not to hedge come in all shapes and sizes: it’s too complex; it’s too costly; there’s a misconception that it is speculation; or even that that firms don’t know about hedging tools and strategies available to them. And in the case that companies don’t hedge despite being aware of its benefits – the excuse is often that exchange rates might even hold steady! These are costly, misguided beliefs!

Many studies show that hedging is a necessary activity for firms operating in the contemporary globalized economy. Benefits include:

– Increase ability to forecast future cash flows

– Minimize the impact of exchange rate volatility on profits

– Diminish the need to attempt to forecast exchange rates

– Helps ‘buy time’ for a company to adjust its marketing and sales strategies should the domestic currency rise in value, thereby reducing the firm’s competiveness abroad

Needless to say, if a firm has the financial ability to hedge at a reasonable cost, there’s no reason not to! Essentially, hedging is like FX insurance.

The next blog post will cover the steps involved with hedging.

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