In today's globalized economy, companies engaging in international trade face various challenges, with one of the most significant being foreign exchange risk. Fluctuations in currency exchange rates can impact the financial performance of businesses operating across borders. Changes in exchange rates can affect the value of revenues, expenses, assets, and liabilities denominated in foreign currencies.

Multinational corporations are acutely aware of how FX markets can impact their profitability and utilize specific tools known as financial derivatives to mitigate currency risk. Here are some of the most widely used tools for FX hedging:

Forward Contracts

Forward contracts are among the most straightforward and commonly used derivatives for hedging foreign exchange risk. A forward contract is a nonstandardized contract between two parties to buy or sell an asset (foreign currency) at a specified future time at a price agreed upon today. The price of the forward is determined by calculating the interest rate differential between the two currencies over the time of the contract. 

Futures Contracts

Similar to forward contracts, futures contracts provide a way for companies to hedge against currency risk by fixing exchange rates for future transactions. The key difference lies in the standardized nature of futures contracts, as they are traded on organized exchanges. Unlike forward contracts, futures contracts can be liquidated at any time if the hedging entity decides that there is a reason to exit the hedge.

Options Contracts

Options contracts provide companies with the right, but not the obligation, to buy or sell a currency at a predetermined price within a specified timeframe. This flexibility makes options a versatile tool for hedging foreign exchange risk. Options are generally preferable for hedging major currencies that trade with substantial volume and liquidity. Options may be exchange-traded or purchased in an over-the-counter (private party) transaction.

Currency Swaps

Currency swaps involve the exchange of cash flows in different currencies between two parties. These agreements help companies obtain more favorable financing terms in foreign markets while mitigating exchange rate risk. Swaps can be a very effective tool for FX risk management, but it can be challenging to find the right counterparty to take the other side of the transaction.  Most swaps are transacted using the services of a swap dealer who has the expertise to match the needs of the two parties entering into the agreement.

Large corporations with a global footprint are the biggest users of derivatives for hedging. Directional moves in currencies can persist for months and result in significant repricing of FX pairs, so big companies include currency hedging in their business plan for international trade. Smaller companies often don’t have the resources to develop their own hedging strategies. Financial derivatives can be complex and it takes considerable expertise to know how to use them most effectively. Many companies have explored hedging strategies only to discover that the cost and time involved in implementing a successful hedging plan doesn’t make sense in terms of return on investment. The result is their company experiences FX losses that have a negative impact on profitability.

Expect Volatility in 2024

2024 is likely to be a volatile year for FX markets. The world is facing the disruptive effects of the global rise in interest rates. An enormous amount of existing debt will be rolled over at much higher rates, inducing stresses on the economies of many nations, particularly emerging market countries. Geopolitical events, including two wars, will contribute to uncertainty and increase volatility. Expectations for central bank policy realignment will also drive FX movement as central banks inevitably attempt to lower interest rates. The upcoming election in the US will also be a major factor in currency pricing and markets will react to every shift in polling as the election nears.

Pangea was created specifically to serve the needs of companies that don’t have the expertise and access to services available to big corporations. Pangea has developed Hedging as a Service (HaaS) so that a small company can hedge FX risk just like a Fortune 500 firm.

Hedge Your Company’s FX Risk with Software

While your company could build out a Treasury department, hire more staff, and go through in-depth quantitative analysis to properly hedge against FX risk, there is another alternative available. 

Pangea created our own in-house quantitative risk team to help our clients assess and manage their FX risk. We took this research, productized derivatives, and then created an Ai-powered FX hedging software so that global companies could access all of this without needing to increase headcount or deal with the costs of banks and consultants to manage their FX risk.

Stop merely bracing for the impact of foreign currency volatility. Schedule a demo today to see firsthand how our FX hedging software works, and get the predictability and control you need going into 2024.