Hedging Strategies Essay Example | Topics and Well Written Essays - 500 words

Hedging Strategies - Essay Example These payments must be made in Euros and hence, Virtual Books is exposed to potential exchange rate risk on these transactions. In order to mitigate and hedge this exchange rate risk, Virtual Books has various alternatives to eliminate this risk. The first alternative is that of Forward Contracts. A forward contract is an agreement between two parties to buy/sell a specified asset at a forward price at a specified date. Forward Contracts are just a commitment to deliver/take delivery of the said asset and at the time of agreement, there is no exchange. Hence the cost of entering into a forward contract is nothing. Other advantages of a forward contract include customization for the customer, and OTC trade. The major drawback is that this contract is an obligation which must be honored. In case it is not honored, the customer can go for or be taken to litigation. In the case of Virtual books, it can enter into a forward agreement with its bank to buy euros at a predetermined forward p rice. By doing so, they can eliminate the potential risk involved in taking a price on the day of the payment. There will obviously be an opportunity cost involved. Assuming that the market is above the forward price on the day of taking up the contract, the customer will be losing out on a potential gain.