What is forward market hedging?

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Karen P.L. Hardison | College Teacher | eNotes Employee

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Forward market hedging is a means by which to protect exposure in the forward currency, interest rate and financial asset markets. The forward market, engaging in large contracts, is dominated by government, institutional and corporate entities.

First: The forward market is an over-the-counter market for forward contracts that do not trade on an established exchange and that are undertaken in large contracts by large investors like financial management institutions. The forward market is for financial instruments like currency, interest rates, commodities and financial assets. The forward market is different from the futures market. Futures trade small standardized forward contracts on futures exchanges. Forward contracts set a fixed price and date for future delivery (as do futures) of an asset or financial instrument. (Barron's Banking Dictionary: Forward Market)

Second: Hedging is an investment strategy whereby various maneuvers may be employed to protect investment value. In financial instrument markets, hedging may take the form of investing in hard-currency securities.

What is forward market hedging?: Forward market hedging is a large scale maneuver for a corporation, government or institutional entity to protect a position in the financial instrument or asset markets. For example, if a corporation expects a weakening of a foreign currency that contributes sales revenue, the corporation might protect profits by securing a forward contract for a currency instrument at a profit-compatible fixed price for delivery at a fixed future date. Forward market hedging is a maneuver to protect against loss in the event of a drop in or weakening of assets, interest rates or currency, but hedging is not without risk as an entity in the forward market may find they have over-hedged (creating a liability, or debt) or under-hedged (thus accruing profit loss).


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