Commercial corporations, unlike other market participants, are part of the 10% of market players who do not partake in the Forex markets looking for profit. Rather, they do so for the sake of hedging risk. Such corporations make transactions in both the futures and spot markets for their daily operations. They need it to pay suppliers for raw materials, as well as to pay employees from different countries.
For example, Corporation A (a US based firm) needs to buy steel from Australia, but needs Australian dollars to complete the transaction. The company will then buy AUD at the spot market so that they can complete the transaction.
Another example would be a company needing steel six months from now. The problem is the company will have to deal with a potential change in currency rates if they decide to buy the in the future. In order to protect itself from potential currency risks, the company can buy a futures contract that will fix the exchange rate. While the company may miss out on if the AUD weakens over the next six months, it also protects itself just in case the currency appreciates. Thus, the use of futures contracts helps to eliminate or limit currency risks.
Vincent Nyagaka is a Professional Trader, Analyst & Author. He has been actively engaged in market analysis for the past 7 years. He has a monthly readership of 100,000+ traders and has taught over 1,000 students since 2014. Vincent is also an experienced instructor and public speaker. Check out Vincent’s Professional Trading Course here.