The forward market hedge

A forward-exchange market hedge involves the exchange of one currency for another at a fixed rate on some future date to hedge transaction exposure. The purchase of a forward contract substitutes a known cost for the uncertain cost due to foreign-exchange risk caused by the possible devaluation of one currency in terms of another. Although the cost of a forward contract is usually smaller than the uncertain cost, the forward contract does not always assure the lowest cost due to foreign-exchange rate change. The forward contract simply fixes this cost in advance, thus eliminating the uncertainty caused by foreign-exchange rate changes. For example, an American company may have a euro import payable in 9 months. The American company can cover this risk by purchasing euros at a certain price for the same date forward as the payment maturity.

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