Hedging against foreign exchange volatility in a world of economic uncertainties

The Australian and Canadian dollars also went down to their lowest points in six years, compared to the US dollar.
China’s yuan was devalued by 4.6 per cent against the US dollar in August.
As a result, South Korea, Malaysia, Vietnam and Thailand are all vulnerable to the yuan devaluation.
There are many reasons for recent volatility in foreign-exchange rates. Firstly, the slump in world commodity prices has impacted negatively on the economy of producing countries.
Some of these countries have cut interest rates to stimulate growth, and their currencies depreciated.
Secondly, the US Federal Reserve has stopped using quantitative-easing policy, and signalled a rise in the fed funds rate, whereas the central banks of Japan and the European Union continue to use quantitative easing.
Thirdly, there is the shrinkage of China’s export sector as a result of the contraction of world demand. Although China announced the yuan’s devaluation in August, it was found that the output growth of manufacturing in October was still at the lowest level in seven months, while the growth rate of investment was the lowest since 2000.
This implied that the Chinese government may have to use monetary policy to stimulate growth, and may depreciate the value of the yuan further.
The factor that may cause the yuan to appreciate is the possibility that it will be accepted into the basket of international reserves called Special Drawing Rights, or SDRs. However, the International Monetary fund already announced a postponement of such a move to next October.
Fears of terrorist incidents can be another threat of market turmoil if the outcomes of recent attacks are escalated further.
Individual and institutional investors such as the Government Pension Fund and Thai provident funds that own equities or other assets denominated in foreign currencies are exposed to fluctuations in the foreign-exchange market.
They may hedge against or speculate on currency risks by using many financial instruments, such as forward currency contracts, currency swaps, currency overlay, currency future contracts, or currency options.
For example, the above analysis indicated that next year the US dollar may appreciate further in relation to the euro. Hence, investors in European stock indexes must protect against a falling euro by buying forward currency contracts that lock in the sale of the euro to the dollar at a current rate on a future date.
Investors who invest in US stocks, on the other hand, are relatively safe from currency risk without any hedging.
Thai exporters that ship their final products to the EU and import intermediate products from the US can also protect against currency risk by buying forward currency contracts that lock in the sale of the euro to the US dollar on a future date.
  
Prof Arayah Preechametta is a lecturer at the Faculty of Economics, Thammasat University.