Foreign Direct Investment and Forwarding Contracts
There are various approaches to deal with exposures and risks associated with foreign exchanges. Hedging is used by companies to limit (reduce) or eliminate financial losses caused by foreign currency exchange risk. Hedging refers to financial instrument deriving value from core assets. Forward contracts, currency swaps, and currency option are major types of hedging commonly used to minimize or remove the foreign exchange risks facing a company. First, forward contracts help to eliminate or minimize the risks and exposures caused by foreign exchange currencies changes. Forward contracts refer to financial contracts that lock in an exchange rate that will apply to a future transaction. They are non- standardized contracts between two parties binding them to sell or buy a specified amount of foreign currency at a pre-agreed currency rate on a specified date. The forward contracts are negotiated between an individual or company and a commercial bank via a telecommunication network such as the internet or the telephone. It states the exact date and the amount of money to purchased or sold and is usually tailored to meet the needs of the firm. In order to apply the foreign exchange forward contract, it is important to provide two currencies that will be involved in the transaction as well as the expiry date. However, it is important to allow some flexibility by providing more than a single maturity date. In addition, forward contracts also imply future currencies. Future currencies require the suppliers to physically deliver an agreed amount of currency at the maturity date as per the terms of the contract. It is a standard contract that is in foreign currency denominations. Secondly, currency swaps help to reduce the risks involved in foreign currency exchange. Currency swaps are agreements entered directly between parties or intermediaries to exchange cash flows in future according to the pre-agreed formula.