Hedging Cost Breakdown

(Return to What is your Pain Threshold?)

The Scenario

Note: In this scenario, there is a small interest differential for the currency pair, so interest costs are low. Some currency pairs (for example, AUD/USD) have larger interest differentials, and could have larger interest costs. Spreads also vary by currency pair, and could be more of a cost factor for other pairs.

In this scenario, your USD$ reporting company has a EUR €750,000 receivable asset in 45 days at a recorded exchange rate of 1.45000 (EUR/USD rate), for a recorded amount of USD$1,087,750. This cost breakdown shows how, for a hedge cost of only USD$982*, your company can guarantee that it receives its USD amount of $1,087,750.

_{* The hedge cost is based on the difference between the selling rate and buying rate of the foreign currency (if you can access competitive spreads, which are relatively fixed during normal trading hours). The hedge cost also depends on the difference in the lending and deposit interest rates on the currencies, traded over the entire length of time that the trade is outstanding (offset by the interest earned on the margin account's balance).}

The Cost Breakdown: