FX Derivatives Case Study

The company’s decision to use FX derivatives to manage the FX risks means that the company already entered into a transaction, or is likely to have a commitment in a foreign currency. Depends on the terms of the transaction the use of some FX derivatives will be more appropriate than the others. For example, if the UK-based company trades on credit, the agreed amount in USD that it supposed to receive is subject to uncertainty in home currency terms. In this case, the company can hedge FX risk exposure by entering into a short USD/long GBP position in forward or futures contracts. The main advantage of this hedging is that it reduces FX risks and provides certainty on the receipt of the future net income. In particular, hedging can add value if net income received in USD represents a greater proportion of total company’s revenue (Muff et al, 2008). Conversely, if the company expected to meet its future liabilities in the US currency to pay out to its suppliers, or finance investment project with high growth opportunities, a long USD/short GBP position in forward or futures contracts can help in budgeting the costs.

FX forward and futures …show more content…
The exchange requires the hedger who holds the position in a future contract to maintain a margin account, which entails an additional cost. However, the main disadvantage of futures is the difficulty of matching the exact amount and the maturity date to hedge the underlying currency exposure, which allows future contracts to be tradable and be closed prior to the maturity date. There are a number of factors that can cause forward and futures prices to be different; although in the FX market the difference is statistically and economically insignificant (Cornell and Reinganum, 1981). Despite different features, both forward and futures contracts serve the same