There are different ways of mitigating the exchange rate risk exposure.
- Natural Hedges
- Cash management
- International financing hedge
- Currency hedge
The relationship between the pricing and the costs of the products and services of a foreign subsidiary, many a times, provides for a natural hedge. The key element is the extent to which the cash flows can adjust to currency rate changes.
A prudent and pro active cash management of intra currencies reduces the risk exposure to a great level. If the movement of the currency rate of the foreign subsidiary can be deduced in advance, the cash reserves can be reduced or increased, the trade credit value (debtors) and trade credit days can be increased / decreased (as the situation warrants). This is called leading or lagging.
International financing hedges
- Commercial bank loans and Trade bills
- Eurodollar financing – deposits outside the US but denominated in US dollars
- International bond financing
- Currency-option and Multiple currency bonds – the right to choose the base currency in which payments are to be made / received
Currency market hedges
- Forward exchange market
- Currency futures
- Currency options
One needs to first understand and conduct an assessment of one’s exchange rate risk exposure before adapting any of the hedging techniques.