The Hedging of Exchange Rate Risk

The Hedging of Exchange Rate Risk -...

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The Hedging of Exchange Rate Risk     Forward exchange contracts A forward exchange contract is a firm and binding contract between a customer  and a bank whereby the parties agree a rate of exchange for the sale or purchase of  a fixed amount of foreign currency at a fixed future date or between two set future  dates.   Banks   are   willing   to   enter   into   forward   exchange   contracts   for   most  currencies for up to one year in advance of the agreed maturity date. For major  currencies such as the yen, the US dollar or the Deutschmark, banks may agree  forward contracts for up to five year periods. In effect, the forward contract fixes a rate of exchange today for a deal which it is  agreed will take place at a set future date or within a set agreed period in the  future. It is important to remember that a forward contract imposes an obligation on the  customer to put into effect the transaction to which the contract relates. Hence, if  the relevant foreign exchange rates have moved in favour of the customer at the  time the contract matures, the customer must still deal with the bank at the agreed  forward rate of exchange. If the customer does not honour his obligation to deliver or take delivery of the  foreign currency as specified in the forward contract, the bank will close out the  contract. This involves the bank in honouring the customer's obligations by buying  the currency at the spot rate and then selling back at the agreed forward rate if the 
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This note was uploaded on 04/10/2012 for the course ECON 101 taught by Professor Gonalez during the Spring '12 term at Université de Bourgogne.

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The Hedging of Exchange Rate Risk -...

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