Hedging an overseas salary can be more complex, because the hedge relates to ongoing cash flow. This means that the exposure exists over a longer timeframe, and therefore the investor is exposed to greater risk and volatility.
For the passive and risk averse, it is possible to calculate one’s annual salary and take out a block-hedge that covers the entire salary against currency fluctuations. For example, with a forward contract, you’d buy the currency now and pay for it after 12 months. This can bring exchange rate certainty, but it also runs the risk of ‘over-hedging’.
For the active types, a ‘rolling hedge’ can be used to try to maximise currency returns, while protecting from downside risk. This is a strategy that uses a combination of hedging products with expiry dates, such as futures or options. As time ‘rolls’ by, and expiry dates are reached, a new position would be opened with the same conditions but a new maturity date. The position sizes could be increased or decreased depending on whether exchange rates move favourably or unfavourably.
Currency risk can rapidly erode profits, especially in times of high volatility. As a result, when exposing oneself to overseas markets, whether that be through a traditional investment, a sale of a property, a commercial purchase, or receiving income, a view needs to be taken about currency risk. Some may feel comfortable with the risk of exchange rate volatility, and wish to try to take advantage of it. Others would prefer not to have such uncertainty. In any event, the risks associated with foreign exchange ought to be considered to ensure one’s personal objectives are not compromised.
To start hedging currency risks, there are a few steps every trader should follow. These are: