Howdy folks,
It's been a while since I've posted in here. Some news for me is that I now work for a foreign exchange risk management company that has a software which helps companies discover where they are exposed to foreign exchange risk. The process of multi-national companies hedging is very interesting, and a little different than how a speculative hedger/carry trader thinks of hedging.
Say a company receives a 10 million dollar contract to build a bridge in another country. The bridge construction could take several years to complete, and the currencies involved in the transaction could change in value drastically in that time.
Now here is how I believe the hedge works. Say the construction firm is US based and the buyer is in Germany. There are two currencies, the functional and the transactional currencies. The functional currency would be USD since that is what the construction company reports in. The transactional currency would be EUR because that is what the German buyer will pay in. If I understand correctly, the contract would then be signed for the transaction amount.
For hypothetical reasons we'll say the exchange rate of EUR:USD is 1:1. Ok so the contract is for 10 million EUR to build the bridge. The buyer is going to pay 10 million Euros at the completion of construction. Now say the dollar appreciates (hypothetical) by the time the bridge is completed to where the ratio is now 2:1. So now when the german buyer pays 10 million euro, the construction company only gets the equivalent in USD or 5 million USD. This would be reported as a loss on their balance sheet since they expected to get 10 million, but only got 5 million.
So what does the construction company do? They make a trade at the signing of the original contract that will offset any gains or losses they may incur in FX translation. In this case their trade would have made them 5 million dollars so that total FX gain/loss is zero.
I'm having a little trouble wrapping my head how this would work for someone on a personal level. Here's what I want to do. I want to completely remove all FX risk from my personal wealth. For example, say the price of a car from germany (I live in the US) is worth $10,000 today. In 3 years it might cost me $15,000 if the dollar depreciates. To me I don't like the idea that my similar work output gets me less bang for my buck in the future. I want the spending power of my personal savings to remain equal for the rest of my life.
How would I go about doing that? If we go into a recession that would mean my savings would automatically grow to a large amount. During expansion my personal savings would drop in dollar value. What instruments can I use to place hedges against this value appreciation and depreciation? Placing a trade on forex wouldn't really do the trick would it? Or would it involve placing a proportionate amount of money and short selling the dollar against another large economy currency like GBP or euro?
This question is getting really long. I think you guys know where I'm trying to go with this.
It's been a while since I've posted in here. Some news for me is that I now work for a foreign exchange risk management company that has a software which helps companies discover where they are exposed to foreign exchange risk. The process of multi-national companies hedging is very interesting, and a little different than how a speculative hedger/carry trader thinks of hedging.
Say a company receives a 10 million dollar contract to build a bridge in another country. The bridge construction could take several years to complete, and the currencies involved in the transaction could change in value drastically in that time.
Now here is how I believe the hedge works. Say the construction firm is US based and the buyer is in Germany. There are two currencies, the functional and the transactional currencies. The functional currency would be USD since that is what the construction company reports in. The transactional currency would be EUR because that is what the German buyer will pay in. If I understand correctly, the contract would then be signed for the transaction amount.
For hypothetical reasons we'll say the exchange rate of EUR:USD is 1:1. Ok so the contract is for 10 million EUR to build the bridge. The buyer is going to pay 10 million Euros at the completion of construction. Now say the dollar appreciates (hypothetical) by the time the bridge is completed to where the ratio is now 2:1. So now when the german buyer pays 10 million euro, the construction company only gets the equivalent in USD or 5 million USD. This would be reported as a loss on their balance sheet since they expected to get 10 million, but only got 5 million.
So what does the construction company do? They make a trade at the signing of the original contract that will offset any gains or losses they may incur in FX translation. In this case their trade would have made them 5 million dollars so that total FX gain/loss is zero.
I'm having a little trouble wrapping my head how this would work for someone on a personal level. Here's what I want to do. I want to completely remove all FX risk from my personal wealth. For example, say the price of a car from germany (I live in the US) is worth $10,000 today. In 3 years it might cost me $15,000 if the dollar depreciates. To me I don't like the idea that my similar work output gets me less bang for my buck in the future. I want the spending power of my personal savings to remain equal for the rest of my life.
How would I go about doing that? If we go into a recession that would mean my savings would automatically grow to a large amount. During expansion my personal savings would drop in dollar value. What instruments can I use to place hedges against this value appreciation and depreciation? Placing a trade on forex wouldn't really do the trick would it? Or would it involve placing a proportionate amount of money and short selling the dollar against another large economy currency like GBP or euro?
This question is getting really long. I think you guys know where I'm trying to go with this.