Hedging

The term comes from the word hedge: “a fence”. The idea is to fence off the result of a deal from market swings. Hedging does not generate profit in itself. It makes costs and revenue predictable.

Which risks are hedged in foreign trade

• Currency risk: an importer pays in foreign currency but earns in roubles. For an exporter, it is the other way around.
• Price risk: the price of raw materials or goods changes between the contract and delivery.
• Interest rate risk: for companies with floating-rate loans.

Methods

Natural hedging does not require financial instruments. The company matches the currency of its costs to the currency of its revenue, agrees on prices in roubles, splits payments into parts, or includes a currency clause in the contract.

Hedging with instruments uses contracts with a bank or on an exchange:

• forward: buying currency in the future at a rate agreed today;
• futures: the same, but a standardized contract traded on an exchange;
• option: the right, but not the obligation, to buy at a set rate; a premium is paid for it;
• swap: exchanging currencies now with a reverse exchange later.

How to choose

Look at the amount and timing of the payment, how precisely the date is known, the cost of the instrument and your access to it. For a single payment in a month, a forward is simpler than an option. For regular purchases, natural hedging is sometimes enough.

Where hedging does not help

If a delivery falls through or is postponed, the instrument remains and may cause a loss. Hedging does not protect against a dishonest counterparty or against a payment failing to go through the banks.

In a deal through a broker, the exchange rate is fixed in the payment order for each payment before the roubles are debited. This protects against swings between signing the payment order and execution, but does not replace hedging months ahead.