Corporations and institutions are some of the largest traders in the currency markets. This is because institutions are some of the largest holders of liquid cash. If a large institution is holding billions of U.S. dollars, that company's exposure to currency risk is incredibly large. If the U.S. dollar were to depreciate, that institution could lose a fortune to currency movement. This was the case for a large amount of U.S. based corporations when the dollar began to drastically devalue in 2002.
To hedge currency positions, institutions must participate in foreign exchange. Both small and large corporations take part in currency hedging through investment banks. Many institutions hire professional advisors when it comes to foreign currency hedging since the positions need to be actively managed. Understanding the correlation between currencies is important when it comes to hedging against institutional positions.For example, the euro and the Swiss franc have a high correlation. A company that is based in Europe and conducts business in euros may not want to hedge against its liquid position with francs. Hedging against the euro with Japanese yen position would be more suitable since the correlation is much lower.In addition to protecting their positions in certain currencies, corporations are also beginning to make currency speculations. Multi-national corporations really have no choice but to participate in foreign exchange. Most corporations purchase their raw material supplies from overseas and must make their payments in the currency denomination where their suppliers are located. Therefore, a business will exchange its currency for the supplier's currency based on that day's exchange rate. Speculation can help a company even out fluctuations in the cost of supplies.
