You'll always hear successful investors saying, "Follow the institutional money." Institutions are the largest players in currency trading. Large institutions typically participate in foreign exchange to mitigate their exposure to profit loss from currency devaluation.
Large corporations transcend geographic differences. Consumers from all over the world patronize companies located on various continents. As our world become more and more of a global economy, businesses will be forced to transact in different currencies.Institutions participate in foreign currency exchange for two main reasons--to hedge against currency devaluation and to pay foreign merchants in their own currencies. The risk of currency devaluation is always present. If a European corporation was holding a large amount of its cash in euros, the company would be significantly impacted if euros devalued. A corporation would reduce its exposure by hedging against the euro in currency trades.Large corporations will also trade forward contracts when they owe debts to foreign merchants. For example, if a business owner in the U.S. owed a supplier in Japan, it would probably pay the Japanese supplier in yen. If yen were to appreciate against the dollar, the U.S. company would be paying more for the same amount of supplies. Forward contracts allow companies to buy a specific currency at a specific price in the future. The U.S. corporation can enter into a forward contract to pay the same price for yen at some point in the future, reducing the impact of currency movements.
