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Thursday, July 12, 2012

Hedging

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Open credit

Open credit allows the importer access to the goods with a promise to repay at a later date. This method of payment exposes the exporter to the greatest amount of risk, as the exporter is totally reliant on the importer’s ability to pay.

Hedging

When two parties agree to exchange currency and finalise a deal immediately the transaction is referred to as a spot exchange.

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The spot exchange rate is the value of one currency in another currency on a particular day.

Therefore, when an Australian tourist in Tokyo goes to a bank to convert her dollars into yen, the exchange rate is the spot rate for the day.

It may not be the most favourable rate because exchange rates can change constantly . Such currency fluctuations can be a cause of real concern for an exporter.

Hedging is the process of minimising the risk of currency fluctuations.

Natural hedging

A number of strategies to eliminate or minimise the risk of foreign exchange exposure. This provides the business with a natural hedge. For example, the range of natural hedges adopted by Kohler BioGenetics Limited includes

· Establishing offshore subsidiaries

· Arranging for import payments and export receipts denominated in the same foreign currency. Therefore any losses from a movement in the exchange rate will be offset by gains from the other.

· Implementing marketing strategies which attempt to reduce the price sensitivity of the exported products.

· Insisting on both import and export contracts denominated in Australian dollars. This effectively transfers the risk to the buyer (importer).

Financial instrument hedging

There are a growing number of financial products available, called derivatives, that can be used to minimise or spread the risk of exchange rate fluctuations.



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