Discuss the relative advantages and disadvantages of each hedging technique:

1. Money Market Hedging

2. Forward Contracts

3. Over the Counter Currency Option

1. MONEY MARKET HEDGING

Advantages

1. fixes the future rate, thus eliminating downside risk exposure.
2. flexibility with regard to the amount to be covered.

3. money market hedges may be feasible as a way of hedging for currencies where forward contracts are not available.

Disadvantages

1. more complicated to organise than a forward contract
2. Fixes the future rate - no opportunity to benefit from favourable movements in exchange rates.  

FORWARD CONTRACT

Advantages

1.They can be matched against the time period of exposure as well as for the cash size of theexposure.

2) Forwards are tailor made and can be written for any amount and term.
3) Forwards are over-the-counter products.5) The use of forwards provide price protection.

Disadvantages

1) It requires tying up capital. There are no intermediate cash flows before settlement.
2) It is subject to default risk.
3) Contracts may be difficult to cancel.
4) There may be difficult to find a counter-party.

OVER COUNTRY CURRENCY OPTION

Advantages

1. They are very cheap to trade
2.They are available on or off exchange
3.Risk is limited to premium (if you are a buyer)
4.Very high potential returns versus risk
5.Lots of strategies to speculate on volatility and price movement

Disadvantages

1.They can be illiquid
2.Quickly become worthless
3.Risk is potentially unlimited (if you are a seller)