In today’s volatile financial markets, forward hedging and forward contract hedging are essential tools for minimizing hedging currency risks. By implementing effective risk management with forward contracts, businesses can secure exchange rates and protect against adverse currency movements. This guide explores best practices for forward contracts, providing a forward hedging example and illustrating the benefits of hedging using forward contracts.

Booking a currency forward contract hedges your adverse currency movement risk, but by adopting the following strategies you may earn good profits out of it.

Always book partial exposure:

Booking a partial exposure is always a good idea. For example, if you are expecting an inward payment of USD 100000 then you may book 50% of your exposure i.e. USD 50000, and keep USD 50000 open.

This strategy will balance your currency exchange rate. If the current spot rate on the date of payment is above your booking rate then you have another USD 50000 to get that rate and vice versa.

 

Making significant bookings when domestic currency has depreciated a lot recently:

If the domestic currency (INR) has depreciated a lot(more than 2% to 5%) recently, you should book your upcoming & future exposure.

For Example, if the USD/INR pair has recently moved to 75 from 72 Rs. In this case, the domestic currency INR has depreciated by almost 4% and is supposed to appreciate in the future or will depreciate by a marginal amount.

So, booking most of your exposure for up to six months in that scenario is advisable.

 

Hedging a little less than your expected payment:

If you are expecting a payment of USD 100000 then most likely you will receive a little less because of correspondent bank charges.

You may receive an amount of USD 99950 in your bank’s Nostro account. So if you are planning to book the entire exposure then always book USD 500 less than your expected payment to avoid cancellation of the extra amount and charges thereon.

 

Check the exact premium before booking a currency forward contract:

You should check the exact premium before booking a contract so that you get exactly what is available in the market. You may refer to currency websites like ibrlive.com which displays the live forward rates.

 

Always opt for a one-month window:

For example, if you are booking a USD to INR forward contract for USD 100000 for a maturity on 20.09.2021 then you should ask your bank to provide a complete month window. You will get a window of one month starting from 20.09.2021 to 19.10.2021.

Please note that this window is provided because sometimes foreign payments can be delayed due to any reason. You will get a premium only till the start date i.e. 20.09.2021 but all your inward payments up to USD 100000 from 20.09.2021 till 19.10.2021 can be converted on the booking rate.

 

Never do booking more than your currency exposure:

For example, if you are expecting a payment of USD 100000 and you are finding the rate very attractive, never book more than your expected payment. Because no one can predict currency movements. In case of adverse movement, you may lose money for cancellation of the extra booking.

 

Book continuously:

Booking continuously is another good practice to follow. Booking currency forward contracts regularly helps to balance your currency rate.

 

Booking immediately after receiving the purchase order:

One should book immediately a partial amount of the contract after receiving the purchase order. This helps you prevent losses on account of adverse movement.

 

Consider booking for a shorter duration if you expect the domestic currency to appreciate.

if you are expecting a depreciation in domestic currency in a short span then you should book contracts for a shorter duration like for 15 days to 1 month.

 

Consider booking for a longer duration when you anticipate a decrease in the value of the domestic currency.

If you are expecting an appreciation in domestic currency then you should book contracts for a longer duration like for 2 months to 6 months.

 

So by following the above strategies, you may hedge currency exposure along with saving extra money. Please note that you should not completely rely on the above strategies as it is the author’s view. You may follow your strategies as well to form the right decision.