01

Hedging Currency Risk With Specialised ETFs

While less conventional, one way to hedge foreign exchange risk is by investing in a specialised currency exchange traded fund (ETF). In principle, a currency ETF functions just like any other ETF, but rather than holding stocks or bonds, it holds currency cash deposits or derivative instruments tied to an underlying currency, which mirror its movements.

02

Hedging Currency Risk With CFDs

A contract for difference (CFD) is a derivative that can be used to hedge foreign exchange risk – to open a CFD position, the trader is not required to own the underlying currency.

A CFD position can be used to offset the currency exposure of the asset being hedged. Because CFDs are a leveraged product, only a small amount of capital is required to enter the hedge. Furthermore, the hedge can be closed via cash settlement, limiting the potential financial outlay of the trade.

03

Hedging Currency Risk With Forward Contracts

A forward exchange contract (FEC) is a derivative that enables an individual to lock in an exchange rate in the present for a predetermined date in the future. The benefit of a forward is that it can protect an individual’s assets from exchange rate movements by locking in a precise value now. The cost or benefit of buying a forward is known at its purchase, with the forward exchange rate calculated by discounting the spot rate using interest rate differentials.

04

Hedging Currency Risk With Options

An option gives the right, but not the obligation, to exchange currencies at a pre-determined rate on a pre-determined date.

There are two types of options: puts and calls. A put option protects an option buyer from a fall in a currency, while a call option protects an option from a rally in the currency. The benefit of such a strategy is that, for a premium, an individual can protect themselves from adverse movements.