Hedging your import, export businesses with derivatives
The asset-trading world is in remarkable balance, and if this sounds like a strange claim,given such high levels of volatility in international markets during recent months, let me explain further.
Open your mind to the concept of balancing your risk by understanding that when one correlated asset goes up in price, the other one goes down in price.
By remembering that it’s a constant balance of weight and counterweight, you can take measures to hedge your import and export trading risks.
A very good example of correlated assets is Gold and the US Dollar (USD). The level of the USD is watched as a benchmark for the health of the biggest economy in the world – the United States.
When the value of the USD falls, usually, the value of Gold rises, because traders want to buy their safe-haven asset – Gold. These are the normal laws of supply and demand, which keep asset trading in balance, and are a clear indication of which way the markets are turning.
All business entities are exposed to some form of market risk. Gold mines, for instance, are exposed to the fluctuating price of gold, airlines are exposed to the price of oil, borrowers are exposed to interest rate changes, and importers and exporters are exposed to currency exchange rate risks.
Specifically, importers and exporters face currency fluctuation risks. For example, when exporting oil from Nigeria, the local currency price is converted into dollars, so if the Naira drops in value due to economic factors, the USD value rises, meaning that less income will be made by local producers of oil. A clear example of this was seen most recently in the deep cuts in Crude Oil, which fell from a range of $90-$110 to $44-$50 in two short months.
A common way to mitigate currency risks is to have some form of hedging strategy, which will balance out the risk of losses. Derivatives such as Contracts For Difference (CFDs) are one way to balance risk. CFDs allow the trader to go long or short on a commodity price without having to buy the actual underlying asset – in this case, Crude Oil.
So, if an oil exporter believes the price will rise past its current level, he or she could take a long position CFD on Crude Oil and vice-versa; if the price is more likely to fall, then a short position CFD on Crude Oil could be taken.
In this way, the exporter could lock in expected revenues at a certain level, even if there are short-term fluctuations that affect the demand for the physical asset.The same approach can be taken on the USD itself, because CFD derivative instruments on currencies are also available.
Building a hedging strategy takes time and research, and it’s always important to get solid financial advice before taking a position. However complex it appears initially, it’s worth taking the time to look into this system of balancing out your risk; there are always risks involved in trading, so why not learn how to hedge them?
• Akinyele works with ForexTime Nigeria
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