Why “Wait & See” is not the best strategy
When we talk about “forex hedging”, we sometimes think of it as an investment concept reserved for those actively
trading currencies or buying and selling goods in foreign denominations. But the fact is, the concept of “hedging”
may appear more frequently in our lives than we think.
The easiest explanation of hedging is to draw a parallel with insurance. Hedging, like insurance, is essentially insuring against a possible negative event. Hedging does not prevent a negative event from happening but if the negative event does occur and you are properly hedged, you may reduce the impact of that event. For example, if you buy home insurance and a break-in occurs, the coverage may reduce your losses.1
When it comes to hedging currencies, the similar concept applies. You are basically hedging to potentially offset the risk of any adverse price movements. For example, an investor buys US dollars (USD) at the rate of MYR3.68 to pay for his son’s education fees in 2016. By locking in the dollars at this price, it may hedge him from downside risk, should the value of the ringgit continues to fall in the future. Without the hedge, he would have to use more ringgit to buy the same amount of dollars in the future. The main goal of hedging is to potentially protect from losses. On the flipside, he may also stand to gain from a currency upside. If the USD continues to rise, he can sell them in return for more ringgit than he used to purchase the dollars. But if the MYR grew stronger, he will get less dollars in return.
Currency movements on the rise
A currency has value, or worth, in relation to other currencies, and its value is influenced by a myriad of economic factors, which causes its value to fluctuate constantly. These fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies.2
Let’s look at the ringgit (MYR) against three major currencies, the US dollar (USD), Australian dollar (AUD) and Great Britain pound (GBP). Comparing the highest and lowest points of these currencies over time, the USD recorded a change of 43.5% in 3 years to 52.7% in 10 years. The AUD rose by 15.8% in 3 years, 20.9% in 5 years and 55.3% in 10 years. The GBP recorded the highest change (57.34%) in 10 years.
Looking from the rear view mirror, it would have paid to hedge on these currencies years ago.
Why do investors hedge?
FOREX hedging may not be necessary, unless the investor has a significant need for foreign currency. In order for the potential savings to be meaningful, the investor may have a need to transact a high amount of foreign currency such as paying for the purchase of foreign property or the repayment of an overseas loan, whereby a constant stream of the foreign currency will be required until the loan is settled. How does that work…?
If you need more information on FOREX hedging, please feel free to talk to HSBC’s Relationship Manager or walk into any HSBC Bank branch for more information.
Sources: 1 Investopedia, A Beginner’s Guide To Hedging, undated. 2 Investopedia.com, “The Effects Of Currency Fluctuations On The Economy” August 8, 2013. 3 Bloomberg, April 19, 2016. 4 The Star, “Ringgit depreciation to boost export, tourism,” January 28, 2015. 5 Bloomberg.com, “Malaysia Scraps Ringgit Peg, Adopts Managed Float (Update4),” July 21, 2005.