Money Market Hedge

AAA

DEFINITION of 'Money Market Hedge '

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 'Money Market Hedge '

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.

 

RELATED TERMS
  1. Accepting Risk

    A risk management method used in the business or investment field. ...
  2. Inflation Hedge

    An investment that is considered to provide protection against ...
  3. Double Hedging

    Hedging a position by using futures and options, thereby doubling ...
  4. Cover

    The act of completing an offsetting transaction so as to eliminate ...
  5. Average Price Put

    A type of option where the payoff depends on the difference between ...
  6. Hedge

    Making an investment to reduce the risk of adverse price movements ...
RELATED FAQS
  1. Why should I consider buying an option if it's out-of-the-money?

    One situation when a trader may want to buy an out-of-the-money option is to hedge a stock position. A trader may want to ... Read Full Answer >>
  2. How do traders use out-of-the-money options to hedge?

    Traders can utilize out-of-the-money options to hedge an existing market position by either buying or selling options. A ... Read Full Answer >>
  3. What is the difference between payment netting and close-out netting?

    Both payment netting and close-out netting are methods of settlement between two or more parties, used to reduce risk exposure. ... Read Full Answer >>
  4. What is the minimum capital adequacy ratio that must be attained under Basel III?

    Under Basel III, the minimum capital adequacy ratio that banks must maintain is 8%. The capital adequacy ratio measures a ... Read Full Answer >>
  5. What industries typically use delta hedging techniques?

    Those industries which are connected to the finance and commodity markets and are trading derivatives are the most likely ... Read Full Answer >>
  6. What are examples of inherent risk?

    Inherent risk is the risk imposed by complex transactions that require significant estimation in assessing the impact on ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    Hedging With ETFs: A Cost-Effective Alternative

    The benefits of ETFs for hedging are clear and investors of all sizes are taking notice.
  2. Options & Futures

    Practical And Affordable Hedging Strategies

    Learn how to find and use the most cost-effective ways to transfer risk.
  3. Options & Futures

    Are Derivatives Safe For Retail Investors?

    These vehicles have gotten a bad rap in the press. Find out whether they deserve it.
  4. Mutual Funds & ETFs

    The VIX: Using The "Uncertainty Index" For Profit And Hedging

    Learn the best ways to profit and hedge using the Chicago Board Options Exchange Market Volatility Index.
  5. Forex Education

    Hedging With Currency Swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it.
  6. Options & Futures

    Getting To Know The Money Market

    If you need liquidity and safety on a sum of money, don't forgo potential interest by keeping the funds as cash.
  7. Markets

    Hedging With Puts And Calls

    This trading strategy can reduce your risk - but only if you use it effectively.
  8. Options & Futures

    Find Profits By Hedging Iron Condors

    Hedging iron condors with put calendars can help control losses, and can even make an investor more profitable.
  9. Options & Futures

    Immunization Inoculates Against Interest Rate Risk

    Big-money investors can hedge against bond portfolio losses caused by rate fluctuations.
  10. Options & Futures

    Does It Still Pay To Invest In Gold?

    This asset's appeal dates back thousands of years. Find out whether it can live up to the hype.

You May Also Like

Hot Definitions
  1. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  2. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  3. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  4. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
  5. International Monetary Fund - IMF

    An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating ...
  6. Risk-Return Tradeoff

    The principle that potential return rises with an increase in risk. Low levels of uncertainty (low-risk) are associated with ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!