It is highly recommended that for smooth investment returns, it is imperative that hedges be put in place in order to manage the currency risks present. Foreign exchange is hard to forecast and the short term projections can go awry at a moment's notice.
"Automatic hedging may also prove to be expensive in the long run. Thus, it is recommended that viewing the movements of the exchange rate in the long term and projecting its possible direction would be used as the basis of any action, whether to hedge on a position or withdraw," according to FXWELLS, a corporate FX hedging service provider based in New York.
The long term projections for currency movements can often be plotted with a simple graph. This determines the past changes of the foreign currency as against the home currency. Aside from past movements, there are other qualitative factors that cast a long shadow on currency risk. These are as follows:
- Monetary Policy. This involves money printing and interest rates of a given country. More money printed means higher inflation and with it, devaluation of the currency. Thus interest rates would play a role in determining investment returns.
- Government Accounts. This involves debts incurred or paid up by a country. The higher the debt, the lower the currency's value.
- Trade Deficit. If a deficit exists, the country is purchasing more than it sells, thus having a higher demand for foreign exchange. With this situation, the currency depreciates.
Thus, looking at a historical chart and current governmental policies can help decide on whether hedging a position is viable or not in the long run. For more advice, go to FXWELLS.
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