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The first recorded use of the word hedge – meaning to dodge or evade – can be traced back to the 1590s, and an understanding of the process is arguably more important in the current financial climate than it ever has been. Recent events have alerted investors to the dangers of excessive risk-taking and the pitfalls of trading without paying due attention to risk management, particularly for currency traders. Participation in the largest of all financial markets comes with its fair share of challenges, and hedging has become a key strategic consideration for any and all involved, whether it be simple or complex in design.
Employed often as a risk management strategy to either limit or offset the probability of losses from fluctuations in commodities prices, securities or currencies, hedging, more than this, serves a number of additional functions. Used also in investment employment to mimimise the risk of adverse price movements, or as a means of transferring risk without buying insurance policies, the risks in question can take very different forms, meaning that there is no single solution when it comes to mitigating the damages.
Recent events have alerted investors to the dangers of excessive risk-taking and the pitfalls of trading without paying due attention to risk management
Commodity risk, for example, arises when adverse price movements impact the value of contracts, and the hedging strategy in this instance calls for commodities’ future or contracts for difference (CFDs); credit risk, on the other hand, arises when the money owed isn’t paid by an obligor, and asks that obligations are sold at a discounted rate. These risks take all manner of shapes, and include interest rate, equity, volatility and volumetric risk, though it’s when it comes to currency risk that the strategy is arguably most important. On this last point, the risks stem from multi-currency activities undertaken by financial and non-financial actors in the global economy. And in answer to these activities, hedging strategies include forward and futures currency contracts, as well as money market operations.
Beset with challenges
The scale and variability of the challenges facing traders mean that trading firms are of real and growing importance when it comes to employing an effective risk management strategy, particularly when it comes to forex trading.
Royal Forex Trading is something of a market leader in an industry beset with challenges. Comprising an elite team of experienced traders and finance professionals both, Royal has carved out a place for itself over the seven or so years in which it has been active by keeping to one conviction: knowing what traders want. “To that end, Royal offers thousands of traders around the world the right tools to make it in the financial markets on a daily basis”, according to the company website. “From superior trading conditions, to tailored personal broker services and close client support, our job is to enable you, the trader, to succeed.”
With an active presence in Australia and Lebanon already, the firm has expansion plans in place to grow in Asia, Europe and Latin America, and remains committed to the task of providing investors, hedgers and traders access to financial markets in an ethical, transparent and efficient manner. With over three million transactions to its name already and a solid financial backbone that includes reserve capital in excess of $5m, through its advanced online platforms, Royal’s clients can enjoy firsthand the experience of a “global partnership and royal treatment”.
Speaking on how hedging relates to Royal’s expertise, the firm maintains that a successful hedge is determined by a number of factors. The first is contingent surrounding circumstances, thus creating the need for a hedge, the second, a sensible and economically feasible environment to warrant its deployment, and the third, an ability to deploy the hedge in a timely manner, both rationally and efficiently. This provision of timely and efficient hedging strategies is perhaps the biggest factor that distinguishes Royal’s performance from that of its competitors, and which has allowed it to form strategic partnerships with clients and investors.
Diverse investment horizons
Experienced trading firms, of which Royal is one, utilise hedging for the purposes of risk management, and while ensuring business flows for firms, hedging enables investors to engage in all asset classes, using a rational, systematic and cautious approach. Royal takes pride in being a pioneering and leading firm in this activity. Understanding that regulators in different jurisdictions face the eternal dilemma of how to protect investors without imposing too many restrictive and suffocating restrictions on the industry, the firm’s ethical and professional responsibilities are best evidenced by its ability to negotiate what remains a trying climate.
Recognising that not all investors have the same risk appetite or investment horizons, Royal’s comprehensive range of financial instruments and diverse account types means that it is equipped to cater for all types of client. Add to that an ability to engage with all types of risk management strategies, and the reasons for firm’s reputation as an attractive investment partner are clear.
The firm has shown itself to be adept at not just natural hedging, which reduces unwanted risk by matching cash flows (i.e. revenues and expenses), but at more exotic methods. Forward hedging, for example, means that while the amount of the transaction changes, the payments procedure and exchange rates are determined in advance, and in a forward contract there is no exchange of money until the agreed-upon settlement date. Similarly, futures refer to a certain amount at a specified date and price, although standardisation, trading domiciliation and the time pattern of cash flows are key points of differentiation. Lastly, CFDs are financial derivatives that allow speculation on price movements through either long or short positions, where the seller pays the buyer the difference between the present value of an asset and its value at the time at which the contract was bought.
Options hedging, meanwhile, is an altogether different animal, and whereas futures are ‘obliging’ contracts for both parties, options, in contrast, give one party the right but not the obligation to buy or sell as asset under specified conditions, whereas the other assumes an obligation to sell or buy that asset if it’s exercised. In doing so, options provide the only convenient means of hedging or positioning ‘volatility risk’. Indeed, the price of an option is influenced by the outlook of an asset’s volatility. Out-of-the-money options may well prove a particularly useful and cost-effective method of hedging against risks with very low probabilities, and ones that, if they occur, have disproportionately high costs.
Looking at the myriad complexities associated with these methods, Royal’s work is made to look all the more impressive, and their contributions do a great deal to underline the importance of hedging in currency markets. Most are familiar with the choices involved in hedging equity and equity futures. One might take an opposite position in futures to protect against systematic market risk, adopt the market neutral approach, where the equivalent dollar amount in the stock trade is taken in futures, or the beta neutral approach in determining the historical correlation between a stock and an index.
Forex hedging
As far as forex hedging is concerned, the vast majority of currency management instruments enable firms to hedge through taking the opposite long or short position. These are tools that effectively serve the same purpose, and include futures, forwards, debt, swaps and options, which all cost the same but differ when it comes to the details.
As an experienced member of the currency trading community, Royal has reached a set of conclusions and summations that stand it in good stead to survive, and thrive even, in the future. First, while governments, corporates and individuals struggle to balance their revenues and expenditures, hedging is, and will continue to be, an indispensable tool. A great many corporate risk managers attempt to construct hedges on the basis of their outlook for interest rates, exchange rates and a variety of market-based factors, however the best hedging decisions are made when risk managers acknowledge that market movements are unpredictable.
The firm goes on to say a hedge should always seek to minimise risk, and should in no way represent a gamble on the direction of market prices. Indeed, a well-designed hedging strategy reduces both the risks and costs for the investor. Hedging also frees up resources and allows management to focus on the aspects of the business in which it harbours a distinct competitive advantage. Hedging increases shareholder value by reducing the cost of capital and by stabilising earnings. From a corporate point of view, leading investors and clients to partake in hedging actively increases business turnover, by adding another layer of defensive activity, so while it comforts regulators on the one hand, it is beneficial for all parties involved.
