More companies are now buying or selling abroad and are at an FX risk. They have a variety of expenses in multiple currencies (like paying suppliers or international payrolls) and/or some of their income is denominated in foreign exchange. That means instability of revenues and profitability and potentially a risk that currencies would move negatively and slash the business performance. That is unless, those foreign exchange balances are hedged.

The Five Pillars of a Successful Currency Hedging Strategy

Whilst each hedging strategy will look different to the next, it is important to review the five key pillars to determine the most appropriate solution for you or your business.

1. Identify: Before taking any action, it’s imperative to identify the extent of your currency exposure to movements in the FX markets. How many positions do you currently hold in the currency market? How frequently do you need to make international payments, are they regular and what size are they? Do you have to occasionally make larger payments?
2. Define Objects: By beginning to understand how much foreign exchange risk you will have throughout 2022 you can then establish the potential impact of exchange rate shifts on your cash flow or budget and define your objectives. How much exchange rate risk are you looking to mitigate and at what cost?
3. Strategy: Once you’ve identified your objectives, you can then discuss your requirements with an international money transfer and currency specialist. Talking through the various currency hedging options will help you ascertain how much of your currency exposure you want to hedge and the most appropriate financial instrument to achieve this. These tools should ultimately help to hedge currency risk and protect your profit. Consultations are free and there are certainly no obligations to go on and trade with a particular currency specialist.
4. Review: Once you’ve implemented your hedging strategy it should be monitored closely and reassessed on a periodic basis to make sure it’s performing optimally. Hedging currency risk is an ever evolving situation as the FX market is always moving.
5. Discover: Use the right hedging provider to get the best rates and closest guidance.

What is the most popular fx hedge?

The most popular tool for the majority of customers would be an FX Forward Contract.

Top 3 Companies for Hedging Currency Risk

• Supported Currencies: 120.
• Clients From: Globally with offices in UK, USA, France, Spain, Ireland, Australia, HK, UAE, Brazil, Gibraltar and Romania.
• Authorised? Yes, by the FCA.
• Guidance / Dedicated Dealer: Yes.
• Online System: Yes, including an app.
• Strong Point: Credibility, Reputation, Liquidity, Level of Service, Best Credit Rating among Peers.
• Operating Since 1979 and Maintaining Excellent Reputation Since. An Industry Leader.
• Rating:
  4.6 /5 on Feefo

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  Editorial (Corporate): 99.4%
• MoneyCorp Review

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• Supported Currencies: 59.
• Clients From: Globally , with the exception of certain U.S states. Offices in UK, EU, USA, Canada, China, South Africa and India.
• Authorised? Yes, by the FCA.
• Guidance / Dedicated Dealer: Yes.
• Online System: Yes, including an app.
• Strong Point: Superb Service, Experienced Dealers, Batch payments, Forward contracts, Multi-Currency Wallets and Rate Alerts.
• One of the leading currency brokerages turning over £7.5bn annually.
• Rating:
  4.8 / 5 on TrustPilot

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  Editorial: 97.8%
• Currencies Direct Review

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• Supported Currencies: 121.
• Clients From: Only accepts corporate clients & does not accept U.S businesses.
• Authorised? Yes, by the FCA.
• Guidance / Dedicated Dealer: Yes.
• Online System: Yes, including an app.
• Strong Point: Exchange Rate Margins of 0.25%-0.15% for Large Turnovers.
• Trading more than $7bn each year.
• Rating:
  9.8 /10 on Feefo

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  Editorial: 91.4%
• World First Review

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For starters, our FX hedging comparison consisted of listing the best companies for buying financial instruments that allow clients to hedge currency risk. While some business foreign exchange specialists such as Moneycorp and Currency Solutions, provide a wide range of FX hedging options, others limit themselves to the simplest of financial instruments or simply spot FX transactions. In our opinion, the companies listed above represent the best balance between service and offerings for the purpose of FX hedging.

Forward Contracts – Currency Hedge 101 – The Best Tool

Provided by most FX companies and Currency Brokers

Forward contracts constitute the simplest currency hedging instrument and are provided by almost all foreign exchange brokers. As one of the most common financial instruments to hedge currency risk, forward contracts act as an agreement between you and a counterparty that consists of exchanging a certain amount of a given currency at a specified time in the future, for a predetermined rate (i.e. today’s exchange rate for a point in the future). As an example, let’s say you are a British citizen looking to buy a property in the US next year. You could enter into a 1 year forward contract where you sell British pounds to buy $300,000 at 1.54. By entering into this transaction, you remove any type of uncertainty related to the cost of the house. After your year is up and you reach the maturity date on your forward contract, you would pay £194,805 and get $300,000 – which will be used for the acquisition of the house.

The agreed upon forward rate in forward contracts is usually linked to interest rate differentials between the currencies involved. Without getting into technical details, the forward curve can be upward or downward sloping. In other words, there are cases where the 1 year forward rate would be better than the current spot rate (which enables you to gain on the hedge) and there are cases where the 1 year forward rate would be worse (therefore, the hedge would have a cost).

Regarding the FX hedge, there are many FX houses that enable the use of forward contracts as an FX hedging tool. Others (such as our recommended companies lower on this page) offer more advanced options for hedging forex.

Pros

• Simple currency hedging instrument
• Liquid instrument especially on short maturities
• Total FX hedge
• Positive carry when the forward rate is better than the spot rate

Cons

• Negative Carry when the forward rate is less attractive
• Inability to capture a favourable market movement

Learn more about its pricing: Currency Forward Contract Pricing.

Limit Orders

Another way of hedging forex is with automatically executed limit orders. Let’s say that the current GBPUSD exchange rate is 1.56. However, your hedging strategy is to try and get an even better rate at some point in the future. Basically, you could set a limit order and ask your dedicated dealer to automatically execute the transaction whenever the GBPUSD rate reaches 1.60. At that moment, you would buy $300,000 and sell £187,500.

Pros

• You have the possibility to get the rate that you want
• No need for you to track things, the foreign exchange contract is automatically triggered

Cons

• No foreign currency hedge if the target rate is not reached
• Your upside potential is limited as you can not fully capture favourable market movements above your limit order

Stop Loss Order

Of all the currency hedging tools, this one is perhaps most useful if you want an FX hedge that protects you against negative market movements, while still retaining the possibility to trade should the rate move in your favour. Let’s say the current GBPUSD is at 1.56 and you want to be able to gain if the rate goes up but manage your foreign exchange exposure should it fall below a certain exchange rate. For example you know that if the exchange rate falls below 1.54 you will not have enough cash to buy your property overseas, so the foreign currency hedge or stop loss order automatically buys USD if the rate moves down to 1.54. The trade has been executed in your ‘worse case’ scenario.

Pros

• Currency hedging for negative market movements
• You retain an upside potential
• Less worries and more possibilities

Cons

• Can lock you in a yoyo market.
• Will not benefit if the rate moves in your favour after it has fallen to the stop loss order

One Cancels Other Order (Currency Hedging with Upside Potential)

This is a combination of both limit and stop loss orders. When combined, the two tools can provide you with a near-complete foreign currency hedge. If using our example the exchange rate hedging would see you set a stop loss at 1.54 and a limit order at 1.58. Whenever either of these rates are reached, the transaction will get executed at that rate. Basically, this would enable you to hedge currency risk against wide market movements while keeping limited upside potential.

As the graph suggests, this kind of order provides currency hedging against severe volatility and enables the customer to keep some upside potential.

Pros

• Limited Risk
• Upside Potential
• Limit or Stop Loss Order will be automatically triggered if the rate is met

Cons

• Limited Upside Potential
• Yoyo moves can drive both gains and losses – with little volatility may not trigger for a long time

Hedging Strategies for Consideration

Natural Hedges

The most obvious approach is to take advantage of any “natural hedges” that occur within your currency exposure. For example, when you generate revenues in a foreign currency it can also be used to pay for costs incurred in the same currency. If the majority of your sales are in USD then you may look to seek financing in USD too. Natural offsets of this sort provide a measure of protection. You don’t have to worry as much about hedging currency risk if you have both revenue and costs in foreign currencies.

Similarly, if you have a heavy reliance on two currencies it may prove beneficial to keep an equal value of each currency. For example, if your company is exposed to GBP and USD, it can offset any GBP depreciation with gains by USD and vice versa.

Natural hedges used on their own do have their limitations and will not provide total protection against currency risk.

Rolling Hedges

Companies with ongoing exposure to exchange rate volatility may use forwards, swaps or options contracts to hedge against currency risk. A rolling hedge will help to mitigate foreign exchange risk by closing a soon-to-expire hedging product (such as a forward or option contract) and simultaneously opening a new contract, pushing back the maturity date of the initial hedging product.

CFO Brian Yoor of the US healthcare giant Abbot implemented a successful 18-month rolling hedge strategy. “ We went through to see where hedges were available in certaincountries and whether they were affordable… we were able to use a blend of certain instruments that generated income for us in a very volatile environment.” Depending on how rates have moved in your currency pair through the duration of your hedging contract it may prove more expensive to renew your existing hedges but Yoor continued “You’re still realizing a benefit, but it’s not as much year-on-year,”

Dynamic Hedging/Pricing

Dynamic currency hedging has traditionally been used as a currency hedging tool for overseas investment portfolios. Mitigating the risk of currency movements to ensure your assets remain a true reflection of their underlying value. Nowadays, technology companies are utilising a similar concept for businesses who sell internationally.

Businesses who sell goods or services overseas with prices in a foreign currency face continuous exposure to fluctuations in exchange rates of those currencies. There are three options the company has:

1. Make no hedges. Simply use the exchange rate available on the day you are looking to repatriate your overseas earnings. Doing nothing is certainly not an active hedging strategy, but taking the rough with the smooth day-by-day is still very much a currency hedging strategy.
2. Pre-Hedge. A company sets their product prices in a foreign currency, which should be based on a target exchange rate. Companies can then hedge their estimated sales volume for a defined period, such as a month or year, in advance. This strategy can allow steady and guaranteed margins for the duration of their hedging tool, but it provides less flexibility to actively respond to market conditions, such as seasonal sales.
3. Dynamic Hedging. A company sets prices based on the daily exchange rate and then hedges accumulated sales at the end of the day or when certain agreed volumes are hit. The company has then hedged all their exposure at the current exchange rate (and with a minimal differential with their target rate). The company can opt to keep prices the same if exchange rates remain constant or change pricing to preserve their profit margins when exchange rates move.

Balance Sheet Hedging

Only available with international money transfer firms who hold a separately regulated subsidiary for options business such as Global Reach Group. Balance sheet hedging is a corporate treasury tool used by businesses to reduce the potential impact of exchange rate fluctuations on their balance sheet.

Successful balance sheet hedging requires firms to measure the impact of FX rates on monetary assets outside of their primary reporting currency, forecasting these assets in advance so they can be hedged (including impacts on the asset from depreciation) and ensuring that liquidity provision (whether in local currency or functional currency as required) does not adversely affect the balance sheet.

Less Common Tools For Currency Hedging:

1. Time Option (Flexible Settlement)

A time option is a type of FX hedging that enables you to settle forward transactions between two pre-agreed upon dates in the future. Let’s say that you are unsure about the exact acquisition date of your property in the United States, this option gives you flexibility as to the execution date of the transaction. The forward rate will be the same and it will usually not involve any premium payment.

Read more about FX options here.

2. Option Structures

FX Options, a form of financial derivatives, are a much more flexible solution compared to a forward contract. The forward contract provides a complete exchange rate hedge in the market by locking in today’s rate for the future. Foreign exchange derivatives or options provide you with exactly as the name suggests – the option, but not the obligation, to buy / sell a currency should certain rate movements or parameters unfold. Basically, any kind of forward could be replicated by the use of options. Options are financial derivatives, that whether bought or sold, enable clients to achieve a particular financial objective. They aren’t particularly common for private individuals but when it comes to currency hedging for businesses, they are more likely to require the flexibility an option can provide.

Please note, that many currency brokers, even the ones offering a wide array of hedging tools for business fx or invidiauls, aren’t able to support option trading. This requires a different type of licensing by the FCA then the standard “international payment regulation” (eMoney or Payment Provider authorisation).

Read more about FX options here.

3. Call Options

A call option is one of the more vanilla foreign exchange derivatives. It is an agreement to buy an asset some time in the future and at a predetermined cost. As an example, a GBPUSD 1 year call option with strike 1.54 enables you to buy GBP and Sell USD in 1 year time at a rate of 1.54. Obviously, at that time, should the spot rate be higher than the strike, you would exercise the option and buy at the strike rate. Should the spot rate be lower than the strike, then you would ignore the option and directly buy in the market.

Obviously one pays a premium in order to have the possibility to enjoy such a possibility. In the case above, the lower the strike rate, the higher the premium of the call option will be.

Read more about FX options here.

4. Put Options

Inversely, the foreign exchange derivative known as a put option agreement gives the possibility to sell an asset at a pre-agreed upon strike rate. As an example, a GBPUSD 1 year put option with strike 1.54 enables you to sell GBP and buy USD in 1 year time at a rate of 1.54. If at that time, the spot rate is lower than the strike, you would exercise the option and make money. In the opposite case, you would just ignore the option and sell at the market spot rate.

You would buy a put option if you need to sell an asset in the future and want to hedge against a depreciation of that asset. Inversely, you would sell it in case you expect the asset price to go up and want to monetize the option’s premium. Just remember, currency providers are not seeking to make a loss on providing options – the more flexibility required, with the right, but not the obligation, to buy a currency, the greater the premium would be (i.e. the amount paid upfront to access the contract).

Read more about FX options here.

5. Participating Currency Forward

As far as FX hedging goes, a participating forward is similar to a forward except that you keep some upside potential by diminishing the notional of the short option. In our case, you buy a put option on GBPUSD with a notional of $300,000 and you sell a call option of the same currency pair with a notional of $150,000.

In this case, imagine the GBPUSD rate goes to 1.58. You would make FX gains and you would pay half the gains you made to the call option buyer (Half Notional of $150,000). In the same case, should the rate go down to 1.50, you would make losses on the transaction, though the put option seller would pay you any loss on the full notional ($300,000). Overall you will have a foreign currency hedge below the strike rate (1.54), and you will be able to make gains above it.

Pros

• Downside Risk Hedged
• Upside Potential
• No Execution related worries

Cons

• Premium to be paid or incurred through worse strike rate

Without getting into advanced technical details, there are countless instruments that make use of a combination of option contracts when hedging forex. These can mitigate particular exposures and/or capture possibilities. We welcome you to read more on our FX options guide for more information on foreign exchange derivatives when conducting foreign exchange hedging for SMEs or individuals.

Having gone through call and put options, let’s have a look at potentially useful structures using a combination of these instruments.

Forex Hedging in a Volatile Market

Since the 2008 financial crisis FX markets have enjoyed, on the whole, over a decade of relative stability. This was particularly true prior to the coronavirus pandemic, with currency volatility reaching an all-time low in January 2020. Sure, the Swiss central bank rocked the currency markets back in 2015 when it removed the swiss franc’s peg to the euro and the pound saw huge drops after its 2016 brexit referendum (in which the value of sterling slumped to a 31-year low on currency markets) but these were both individual shock events. Low inflation and record low interest rates across pretty much all developed nations have helped to smother any big swings in exchange rates.

And whilst these trends in inflation and interest rates continued in 2020 and 2021, currency volatility did actually increase due to the unforeseen impact of coronavirus and the economic shutdowns that followed. As an example, at the peak of global lockdowns it caused a crash in fuel prices which had a knock-on impact to currencies such as NOK (Norway) and CAD (Canada) – two countries that generate significant revenue from oil exports. The emergence of new coronavirus variants such as Delta and Omicron also caused short-term periods of currency volatility.

With 2022 being the year that we started to see rate hikes again, and 2023 expected to show more rate hikes, this decade could prove much more volatile than the last. Building the correct hedging strategy will be an important step for individuals and businesses who have significant currency exposure in the FX markets.

Hedging, defined as using a strategy to offset the risk of market movements, may not always be the correct course of action to manage your foreign exchange exposure but in most cases currency hedging can help you strike the right balance between risk and reward. If you hedge all of your currency exposure it means you could miss out on the positive impact of exchange rate moves in your favour but by not hedging at all you could lose out if the market moves against you.

Conclusion – Managing Foreign Exchange Risk

At a time where market volatility makes a great impact on individuals’ and businesses’ budgets, it has become essential to plan ahead carefully and be aware of the currency risk one is exposed to, because this aspect can determine your business’ success or lack thereof.

Hedging currency risk by using an FX hedging tool can provide much more protection to you or your business than being at the mercy of spot rates but depending on the types of currency hedging instruments you choose and the rates you are looking to achieve, you have to be aware there is a chance for downside too. While some would consider technical proficiency as a sign of performance, others would see simplicity as the ultimate sophistication.

At money transfer comparison.com, we believe that not only is it essential to conduct FX hedging and mitigate risks, but it is even more essential to understand what one is doing. In this regard, we advise our clients to hedge using simple instruments:

• Vanilla Forwards (Normal Forward)
• Limit Orders
• Stop Loss Orders

We also recommend our readers only deal with companies who have a strong reputation for having a knowledgeable and professional team and have a long track record of providing currency hedging tools, whilst developing tailored hedging strategies for their clients. Given our performance assessments, along with customers’ feedback, we recommend buying FX hedging products through MoneyCorp and Currency Solutions.

Below you can find a finite list of all the companies we have covered which offer currency hedging functionality for private clients and SMEs.

This is an updated list for 2022 of all the providers we have reviewed offering currency hedging instruments: