Topic Description & Details

Money Market Hedge - In a nutshell, a money market hedge can be described as a technique

to secure the home currency value of a foreign currency transaction. Money market hedging

uses borrowing and lending operations in foreign currencies (ScienceDirect,n.d). According

to FITT, Money Market Hedge is based on a loan in a foreign currency and is a sort of

exposure netting. When businesses conduct business abroad, a local company can lower its

exchange rate or currency risk with the aid of a money market hedge. This technique requires

depositing money into a money market, which is a financial market for highly liquid and

short-term instruments like treasury bills, bankers' acceptances, and commercial paper

(Money Market Hedge: Definition, Strategy, Process, and Example, 2022). Without a money

market hedge, a domestic company would be vulnerable to changes in exchange rates. This

could result in a significant effect on the transaction’s pricing. Different currency rates can

make the transaction more affordable, but they might also raise the cost and make it

unprofitable (Money Market Hedge: Definition, Strategy, Process, and Example, 2022).

History

Commodities were involved in the expansion of future and option trading on exchanges from

the middle of the 19th century until the late 1960s. The advent of trading on exchanges in an

expanding variety of financial futures and options has been associated with the massive rise

of financial derivatives from the late 1960s. The fundamental characteristic shared by all of

these instruments is that they are designed to disperse risk across a larger area, allowing the

parties engaged in the buying and selling to manage better their investments and the risk

exposure of their portfolios. Although a wealth of information is available to evaluate

hedging instruments, much remains to be discovered about some of them, such as the actual

value of hedge funds (Conford,1995). Now, money market hedging has played a crucial part
in financial markets in ascending countries. It is easier to trade short-term fixed-income

securities and funds (Onyiriuba, 2016).

Advantages

● Safety - It provides safety since it uses short-term instruments that generate fast cash

flows.

● Assured Return - Investors get assurance that they will get back their returns

whether or not it is more or less than what was initially invested.

● Liquidity - Many investors lend and borrow money. As a result, the market has

greater liquidity and has quicker access to cash.

● Federal Backing - If the company should ever go bankrupt, the federal backing will

assist in recovering some of the investment.

Disadvantages

● Hard to Execute - It can be hard to execute if investors or businesses don’t have

much knowledge.

● Volatility - With the high volatility in exchange rate it can make the technique less

efficient

● Disclosure - Using hedging tools always causes an issue on financial reports. It

becomes a challenge for accountants because you can't determine the value of hedging

products owing to volatility. This is because even if they don't intend to sell the deal

at a loss, if they show it at market price and it is a loss, it doesn't look good for the

company.

● Not Flexible - Money market hedges can be very rigid. This is due to the fact that it

carries a legal responsibility to deliver the item or make the payment by the

predetermined date and price.

 ● Opportunity Costs - Businesses may not be able to participate in any developments

involving that asset once they have signed a hedge contract. The reason for this is the

exchange rate. As a result, you miss the chance to increase your profit.

Applications

To better understand the money market hedge, we can use an American business that is aware

that it must pay an Italian business in euros rather than dollars. They plan to get their supplies

within six months. The American business might utilize a money market hedge for retaining

the value of the euro relative to the dollar at the present rate so even if the dollar loses its

value against the euro in six months. The money market hedge would aid in knowing exactly

what the transaction cost will be in dollars and can plan appropriately. The following would

carry out the money market hedge:

● Purchasing at the spot rate the current value of the foreign currency transaction

amount.

● Storing the purchased foreign cash in a money market deposit account while

collecting interest up until payment is made.

● Making the foreign currency payment using the deposit.

Topic Description & Details

Forwards: According to FITT, an FX forward contract is an organization’s commitment to

exchange predetermined amounts of two different currencies at a future date. The rate of

exchange between these two currencies is guaranteed by the contract. Because of this

guarantee, the organization knows in advance how much of its own currency it will receive in

exchange for foreign currency, even as the exchange rate changes over time.
History

“Forward contracts date back to antiquity. Because of transportation and communication

challenges, trading on samples was common, and some form of forward contracting was

required. Only the producers and consumers of the traded goods were typically involved in

the contracting process.”

References
Borad, S. B. (2022, December 31). What are the Advantages and Disadvantages of a Money

Market Hedge? eFinanceManagement. https://efinancemanagement.com/international-

financial-management/advantages-disadvantages-of-money-market-hedge

Cornford, Andrew. 1995. “Risks and Derivatives Markets: Selected Issues”. UNCTAD

Review. Geneva: United Nations Conference on Trade and Development, p. 190.

Money Market Hedge: Definition, Strategy, Process, and Example. (2022, September

18). Investopedia. https://www.investopedia.com/terms/m/money-market-hedge.asp

ScienceDirect (n.d.). https://www.sciencedirect.com/topics/social-sciences/money-

market