Money Market Hedge

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DEFINITION

A money market hedge helps a domestic company reduce its currency risk when doing business with a foreign company. It allows the domestic company to lock in the value of its partner’s currency (in the domestic company’s currency) in advance of an anticipated transaction. This creates certainty about how much a future transaction will cost and ensures the domestic company can lock in a price that it is willing and able to pay.

INVESTOPEDIA EXPLAINS

Without a money market hedge, the domestic company would be subject to exchange-rate fluctuations that could dramatically alter the transaction’s price.  While exchange-rate fluctuations could cause the transaction to become less expensive, they could also make it more expensive and possibly cost-prohibitive.

For example, if an American company knows that it will need to purchase supplies from a Spanish company in six months, for which it will have to pay in euros rather than dollars, it could use a money market hedge to lock in the value of the euro relative to the dollar today so that even if the dollar weakens relative to the euro in six months, the U.S. company will still be able to purchase its supplies from Spain at the original rate.

If the U.S. company did not want to use a money market hedge, it could also use a forward contract, use an FX swap or simply take a chance and pay whatever the exchange rate happens to be in six months.

 


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