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Forex Trading for Hedging Against Currency Risks
Education | 11 April 2012
By: Tho Mun Yi
Articles (2) Profile

Holding foreign stocks exposes the investor to both the stock’s risk and the foreign exchange risk. When deciding to invest in a foreign stock, the investor will have to make two separate decisions, which are whether or not to buy the stock and if he should buy the stock, and should he hedge against currency exchange rate risk.

For instance, you currently live in Singapore, but have purchased US shares. This makes any profit that you may earn very susceptible to USD/SGD fluctuations. A drop in the USD/SGD from 1.2600 to 1.2000 would translate to a decrease of 4.76% in your profits. What should you do?

The solution
The solution to this problem with currency risk is Forex trading. Forex trading is not only used to make money, it can also be the ideal financial tool for hedging against currency risks. You can easily hedge your currency risk through any online retail Forex broker. What you should do is open a Forex trading account, deposit the necessary funds and sell or go short on the USD/SGD.

Assume that you intend to invest USD 1,000 in US shares. The current USD/SGD is 1.2600. This means you are investing SGD 1,260 at this point of time. In order to prevent any loss, open a short USD/SGD position to sell USD 1,000 against the SGD at USD/SGD 1.2600 the same time you make your US shares investment.

USD/SGD drops
In the event USD/SGD drops from SGD1.2600 to SGD1.2000 at month end, your currency gain of SGD 60 from Forex trading will offset your currency loss of SGD 60 from buying US shares. In this case, a currency gain in Forex trading offsets the currency loss in buying US shares.

USD/SGD rises
Conversely, if USD/SGD rises from SGD1.2600 to SGD1.3200 at month end, your currency losses of SGD 60 from Forex trading will be offset by your currency gain of SGD 60 from buying US shares. As such a currency loss in Forex trading is offset by the currency gain in buying US shares.

The objective is to hedge
With this hedging strategy, gains from Forex trading are used to protect your US investments against any losses due to currency depreciation. Consequently, the misconception that foreign share investments cannot be hedged is busted!

Tho Mun Yi is a licensed Associate Financial Planner Malaysia. She is also a fulltime unit trust consultant since 2008. Her financial and academic articles have been published by various publications and websites.

She can be contacted at thomunyi@gmail.com

Please click here for more information about this author.


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