3. Forward exchange rates are determined by interest rate differentials -banks try to predict the future interest rates of the two countries in question and set the exchange rate so that no arbitrage opportunity would exist. If the currency sells at a premium in the forward market it doe not necessarily mean that it's going to appreciate and vice versa. Consequently, any risk-averse company should always hedge against the foreign exchange exposure. Hedging though the forward market provides several advantages as well as disadvantages for the company exporting products to other countries.
             A forward contract allows the exporter to fix in advance the amount of local currency proceeds from exports. First, a forward transaction is relatively inexpensive, as the only cost for the exporter is the transaction spread. Second, no up-front payment is necessary, no cash is paid until the settlement date and there is no cost of carry. Third, the forward market is not regulated and transactions are done over the counter, allowing for more flexibility in transaction terms, for instance in amount and settlement date. The market is large, efficient and liquid, with small price variations.
             On the other hand, there are several disadvantages of using forwards. First, from the bank's point of view, any forward transaction is equivalent to extending a loan, which limits the exporter's borrowing potential. Moreover, forwards are not tradable, implying the exporter's obligation to settle the contract at maturity. Also, the settlement date being fixed, the exporter bears the risk to receive the export proceeds at a different date than the forward contract maturity. Last but not least, entering a forward transaction involves a significant opportunity cost: the exporter is not able to benefit from potential favorable FX rate movements.
             As a conclusion, a company that cannot absorb any loses associated with foreign exchange exposure should always hedge eit...