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The Hedging Problem with Illiquid Markets: Why the Japanese Yen Can Trouble Your Business

Falling Into The Volatility Trap

All business owners with commercial ties to countries experiencing major economic transitions are at risk of fluctuations in currency valuation. A fairly risky currency is the Japanese Yen. In part, this is due to the rapidly changing economics of Japan and the government’s decision to float the currency, but perhaps even more significantly is due to the country’s tightened restraints on the outflow of capital. This increases currency speculation and provides traders with opportunity for profit. While traders may enjoy the huge opportunity for profit, business owners shudder at the volatility-induced risk - risk so pervasive that the investment and commercial ties may ultimately be a prove to be a poor decision.

Volatility That Hurts

As the chart above shows, currencies such as the Japanese Yen are volatile due to the economic situations of their respective geographical regions. If an export/import company does shipping with one of the extremely volatile markets, they are faced with large amounts of unhedged risk. These sudden and significant changes that occur due to the extreme volatility can spell disaster to a company that does not plan or protect themselves from this threat.

Solution: Leverage With Major Currencies

So how can a business survive a risky currency? One way is to avoid the risk by minimizing their commercial dealings with volatile currencies like the Japanese Yen. However, for many businesses this is an unacceptable solution; in which case a proper risk management hedge is the only option. By using the FX market, individuals and businesses can easily hedge their exposed risk away. If a business’s risk is of the Yen depreciating in value, then the appropriate hedge would be to short YEN and long USD. Because a business can customize the amount of leverage they use, (all amounts up to 100:1) even a perfect hedge is possible.

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