Small business owners juggle numerous responsibilities, but one of the most crucial is related to the risks of inflation and currency devaluation. The majority of domestic companies hold most of their assets in their home nation’s currency. Usually done for the sake of convenience, the practice opens businesses up to deterioration of financial assets should inflation take hold. Likewise, if the home currency falls against others, owners can get stuck with a bank account that is worth much less than it could be.
What’s the solution? Luckily, savvy managers and principals in companies of all sizes use foreign exchange markets to offset some of the most pernicious forms of monetary risk. When it comes to rising prices and international inflationary pressures, decision makers in organizations can use forex strategies like hedging, carry trades, and arbitrage to combat inflation.
Additionally, many company finance departments set up forex accounts for the purpose of speculation, the same way individuals buy and sell FX pairs in the hope of earning a profit. The following techniques are the most common ways that business entities keep inflation and other risks as low as possible.
In general, hedging any kind of securities position involves being long and short at the same time. When trying to avoid losing money with Forex and working with an FX account though one of the better-known brokers like Avatrade, businesses tend to engage in hedging when they believe they have over-exposed themselves to a given currency. If ABC company purchased $1 million worth or Japanese yen, they could hedge by entering into a contract to sell yen for a percentage of their total long holdings.
The main benefit of tactics like hedging, carry trades, and arbitrage is that account holders can calibrate their positions in such a way that they’re less exposed to risky situations, fast price changes, and domestic economic problems like inflation. Carry trades are a good example. The approach requires the user to find a borrowing source that charges less interest than an available investment.
In consumer finance, the principle is quite clear. Credit card companies regularly advertise zero percent interest for up to six months. Some working people take advantage of those situations by borrowing on the zero-interest card and investing the cash in an account that pays interest. Properly played, this carry trade example could net the individual several hundred dollars in interest due to their ability to use interest-free funds, even temporarily.
Arbitrage is similar in concept but calls for a slightly different form of execution. The ultimate short-term maneuver, arbitrage is about finding price differentials in any market and taking advantage of them. In forex, a trader might discover a way to purchase yen for a specific price, while simultaneously locating a buyer who is willing to pay more than that. Arbitragers are middle-men who profit for these small differentials.
In the above example, suppose the sale price for yen was $.025, but the willing buyer is paying $.027 for yen. To profit from the arbitrage move, you could purchase 1,000,000 yen from the low-priced seller, and then sell them to the party willing to pay $.027, for a net profit of $2,000. Commercial entities hold FX accounts with major brokers for all sorts of reasons. Hedging against inflation and deteriorating local currency values are the most frequent incentives to do so.
If the majority of your assets are valued in dollars when the US inflation rate begins to rise, it’s wise to contact your financial advisor, and take action. But how? For decades, treasurers and financial operatives in corporate offices have turned to foreign currencies as a way to build a hedge against inflation. In fact, the approach is simple: look for one or more foreign currencies that are appreciating faster than the domestic inflationary rate. So, if US inflation is at 9%, the strategy would be to purchase yen, yuan, euros, or pounds to beat that 9% rate. In the past, the yen has provided the most reliable counterbalance to dollar denominated holdings, followed by the euro and the pound.
Following the Trend
For FX enthusiasts who work for themselves or for large commercial organizations, trend trading is one of the preferred tactics for playing the foreign exchange markets. The technique focuses on not only identifying in which direction the primary trend is moving but also how strong it is and how long it’s likely to last. In most of its variations, the strategy is similar to the way people speculate on stocks, options, and commodities. For account holders who buy and sell forex pairs, the basic way to engage in trend following is to aim for long-term profits instead of short-term gains.
Any financial information or opinions contained in this article are the author’s own and do not represent endorsement or support of any products or services by SmallBizClub.com.