Money Market Hedge
What Is a Money Market Hedge?
A money market hedge is a technique used to lock in the value of a foreign currency transaction in a company's domestic currency. In this way, a money market hedge can assist a domestic company with diminishing its exchange rate or currency risk while managing business transactions with a foreign company. It is called a money market hedge on the grounds that the interaction includes depositing funds into a money market, which is the financial market of profoundly liquid and short-term instruments like Treasury bills, brokers' acknowledgments, and commercial paper.
Money Market Hedge Explained
The money market hedge permits the domestic company to lock in the value of its accomplice's currency (in the domestic company's currency) in advance of an anticipated transaction. This makes certainty about the cost of future transactions and guarantees the domestic company will pay its desired price to pay.
Without a money market hedge, a domestic company would be subject to exchange rate variances that could emphatically change the transaction's price. While changes in exchange-rate rates could make the transaction become more affordable, variances could likewise make it more costly and perhaps cost-restrictive.
A money market hedge offers flexibility with respect to the amount covered. For instance, a company may just need to hedge half of the value of an impending transaction. The money market hedge is additionally helpful for hedging in exotic currencies, like the South Korean won, where there are not many alternate methods for hedging exchange rate risk.
Money Market Hedge Example
Assume an American company realizes that it needs to purchase supplies from a German company in six months and should pay for the supplies in euros as opposed to dollars. The company could utilize a money market hedge to lock in the value of the euro relative to the dollar at the current rate so that, even assuming that the dollar debilitates relative to the euro in six months, the U.S. company knows precisely exact thing the transaction cost will be in dollars and can budget in like manner. The money market hedge would be executed by:
- Buying the current value of the foreign currency transaction amount at the spot rate.
- Putting the foreign currency purchased on deposit with a money market and it is made to get revenue until payment.
- Utilizing the deposit to make the foreign currency payment.
Money Market Hedge versus Forward Contract
If a U.S. company can't or doesn't have any desire to utilize a money market hedge, it could utilize a forward contract, foreign exchange swap, or just take a risk and pay anything that the exchange rate is in six months. Companies might decide not to utilize a money market hedge in the event that they perform a large number of transactions in light of the fact that a money market hedge is normally more confounded to coordinate than a forward contract.
Features
- It permits a company to lock in an exchange rate ahead of a transaction with a party overseas.
- Money market hedges are ordinarily more convoluted than different forms of foreign exchange hedging, like forward contracts.
- A money market hedge is a device for overseeing currency or exchange-rate risk.
- Money market hedges can offer some flexibility, like hedging just half of the value of a transaction.
