Money Market Hedge refers to the method of using foreign currency to reduce transaction or accounting risk in foreign exchange exposure. It involves a contract and a source of funds to fulfill that contract. In this instance, the contract is a loan agreement.
The firm seeking the money market hedge borrows in one currency and exchanges the proceeds for another currency. Funds to fulfill the contract, that is, to repay the loan- generated by business operations, in which case the money market hedge is covered. Alternatively, funds to repay the loan may be purchased in the foreign exchange spot market when the loan matures. In this instance, the money market hedge is uncovered or open.
For example, a Canadian company knows that it has to buy products from a French company within five months and it must be paid in euros rather than in Canadian dollars.
The company may utilize the money market hedge technique to fix the value of the Euro compared to the Canadian dollar at the present rate so that if the Canadian dollar falls compared to the Euro in the next five months, the Canadian company knows accurately what the transaction cost would be in Canadian dollars and so they can budget appropriately.
Use of this Term in Sentences
- A money market hedge is a method for controlling currency or exchange-rate risk.
- A money market hedge enables a corporation to lock in a rate of exchange ahead of a transaction with a foreign party.
- Money market hedges provide some flexibility, like hedging just 50% of the total transaction value.