Financial hedging, when done right, has many advantages that you can enjoy at relatively little cost. And financial hedging can be used a number of ways to benefit a business and protect it from wild swings in everything from commodity prices to interest rates to currency values. Here is an overview of how financial hedging can work to your advantage in a volatile market.
You Protect Your Profit Margins
Hedging with futures lets producers lock in a price that reflects business goals. For example, the futures contract could be set to guarantee you earn a minimum profit margin. You’ll potentially lose out on a larger profit margin, but you’ve prevented losses if prices come in below your price threshold. In short, hedging can create a type of price-insurance.
Hedging can be used to protect a business from the upswing in the cost of a key commodity or foreign currency, as well. Ensuring that a jump in the price of a commodity your business relies on won’t go up too high keeps operating costs predictable. You can use a mix of options to guarantee that you’ll never pay more than a certain price range for key products.
Using hedging to protect against swings in the value of currency provides protection for exporters, importers, and banks. This is especially important if you’re doing business in countries with an unstable political or financial climate.
You Guarantee a Rate of Return
Financial hedging allows a business to see a predictable rate of returns. Read more information on financial hedging products before you start trying to use hedging to guarantee returns. Hedging of investments can ensure that no capital is lost before it is needed, though it will slow the rate of growth for the investment. However, hedging is a good way of protecting the business’ sustainability because you don’t lose that critical nest egg.
By investing the money and then hedging the investment, you guarantee that the money grows instead of sitting in a bank and losing value due to inflation. Or, you can use hedging to ensure that you aren’t charged more than a certain interest rate on debt, making it easier to guarantee that you can service that debt.
You Can Diversify Safely
Hedging can allow your business to invest while limiting the potential downside. This makes it possible to diversify safely. You can even use hedging to provide potential upside whether the price of something goes up or down.
If you think you’ve made an incorrect decision regarding an investment, you could execute an alternative order, essentially correcting the decision. If the price of futures goes up, the person who sold futures to hedge their market position may have to pay an additional margin but holds a more valuable item that can be sold to offset that cost.
You Improve Your Attractiveness to Lenders and Investors
Whether you’re trying to attract investors or competing for business loans, the fact that your business uses financial hedging to prevent catastrophic losses and lock in minimal profits makes it more attractive to financial institutions. They may be more willing to risk their money with you because you can demonstrate how you’re minimizing that risk. They will also be able to make clearer projections since they’ll be able to calculate production costs better.
Financial hedging is an invaluable tool for businesses to manage risk and protect their profit margins. However, you should know what you’re doing and why to minimize the associated costs and ensure that the hedging strategy guarantees your desired end result.