A hedge is an investment position intended to offset potential losses/gains that

may be incurred by a companion investment. In simple language, a hedge is

used to reduce any substantial losses/gains suffered by an individual or an
organization.
TYPES OF HEDGING
SHORTHEDGING
Take a short hedge position in the futures market.
Appropriate when someone expects to sell an asset he alread y owns and
wants to guarantee the price.
LONG HEDGE
Take a long position in the futures market
. Appropriate for someone who expects to buy an asset and want s to
guarantee the price.

Perfect hedge does not always exist

The asset we are trying to hedge may not be exactly the same as the asset
underlying the futures. The time at which we sell the asset (which could be
random) might not be exactly be the same as the delivery date of the futures.

What it is:
Foreign Exchange (FOREX) refers to the foreign exchange market. It is
the over-the-counter marketin which the foreign currencies of the world are
traded. It is considered the largest and most liquid market in the world.

How it works/Example:
Foreign Exchange has no centralized market. Instead, a foreign exchange
market exists wherever the trade of two foreign currencies are taking place. It
is open 24 hours a day, five days a week. This foreign exchange market exists to
ease investment and trade. The primary trading centers are London, Paris, New
York, Tokyo, Zurich, Frankfurt, Sydney, and Singapore. All levels of traders, from
central banks to speculators, trade currencies with one another.

Why it Matters:
Without this mechanism in place, foreign trade and investment would be
impeded. Since many currencies abound along with a few major players like the
U.S. dollar, the British pound, and the euro, this apparatus provides
a clearinghouse to trade those major currencies.
characteristics:

its huge trading volume representing the largest asset class in the world
leading to high liquidity;
its geographical dispersion;
its continuous operation: 24 hours a day except weekends, i.e., trading
from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
the variety of factors that affect exchange rates;

the low margins of relative profit compared with other markets of fixed
income; and

the use of leverage to enhance profit and loss margins and with respect to
account size.

Historically, only large financial institutions, corporations, central

banks, hedge funds and extremely wealthy individuals had the
resources to participate in the forex market. However, now, with
the emergence and popularization of the internet and mainstream
computing technology, it is possible for average investors to buy
and sell currencies with the click of a mouse from the comfort of
their own home.
This is not as risky as it sounds, because currencies don't
fluctuate as much as stocks.

Rank

Name

Market share

Citi

16.04%

Deutsche Bank

15.67%

Barclays Investment Bank

10.91%

UBS AG

10.88%

HSBC

7.12%

JPMorgan

5.55%

Bank of America Merrill Lynch

4.38%

Royal Bank of Scotland

3.25%

BNP Paribas

3.10%

10

Goldman Sachs

2.53%

DEFINITION OF 'FOREIGN-EXCHANGE RISK'

1. The risk of an investment's value changing due to changes in
currency exchange rates.
2. The risk that an investor will have to close out a long or short
position in a foreign currency at a loss due to an adverse
movement in exchange rates. Also known as "currency risk" or
"exchange-rate risk".

INVESTOPEDIA EXPLAINS 'FOREIGNEXCHANGE RISK'

This risk usually affects businesses that export and/or import, but
it can also affect investors making international investments. For
example, if money must be converted to another currency to make
a certain investment, then any changes in the currency exchange
rate will cause that investment's value to either decrease or
increase when the investment is sold and converted back into the
original currency.
HOW TO HEDGE
Foreign exchange risk (also known as FX risk, exchange rate
risk or currency risk) is a financial risk that exists when a financial transaction is
denominated in a currency other than that of the base currency of the company.
Foreign exchange risk also exists when the foreign subsidiary of a firm maintains
financial statements in a currency other than the reporting currency of the
consolidated entity. The risk is that there may be an adverse movement in
the exchange rate of the denomination currency in relation to the base currency
before the date when the transaction is completed.[1][2] Investors and businesses
exporting or importing goods and services or making foreign investments have
an exchange rate risk which can have severe financial consequences; but steps
can be taken to manage (i.e., reduce) the risk.[3][4]

(a) Forward contracts

The client can use forward contracts to sell or purchase foreign currency amounts at a future
time and a given exchange rate. The settlement takes place at the time and the exchange rate
mentioned in the contract, regardless of any fluctuations of the exchange rate on the foreign
exchange market.
Benefits

The risk of exchange rate fluctuations is mitigated

It increases the managements control over the companys cash-flows and profitability

The exchange rate used in budgeting is fixed ex ante

This product is suitable for your business if:

Your incomings are denominated in one currency and your payments are denominated
in another currency

You have a time gap between incomings and the corresponding payments

You use a certain level of the exchange rate when pricing your products
(b) Flexible forward transactions
A flexible forward transaction has the same characteristics as a forward transaction with only
one specific difference, which is that the settlement of the transaction can take place at any time
until the maturity of the contract. The client may choose to make partial settlements for his
transaction at any time until the maturity of the contract, having the only obligation to exchange
the entire notional amount until maturity.
Benefits

Flexible tenor for the foreign exchange transactions as the settlement may take place at
any time until the maturity date, at the same pre-established exchange rate

Better liquidity management

Better coordination between incomings and payments

This product is suitable for your business if:

Your incomings are denominated in one currency and your payments are denominated
in another currency

You have a time gap between incomings and the corresponding payments

You can anticipate the total volume of you payments but you cannot be certain in what
regards the exact moment of your incomings

You use a certain level of the exchange rate when pricing your products
(c) FX Options

FX Options give their buyer the right but not the obligation to sell/buy a specific amount at a preagreed exchange rate. In order to have this right, the client pays a premium.
An option contract has the same functionality as an insurance contract. The client pays a
premium in order to be able to take advantage of its right in case a certain event occurs.
Benefits

Complete foreign exchange risk hedging

Better cash-flow and profit management

Establishing a level for the exchange rate that will be used for constituting the budget of
the company

The possibility to benefit of a favorable exchange rate movement

This product is suitable for your business if:

Your incomings are denominated in one currency and your payments are denominated
in another currency

You have a time gap between incomings and the corresponding payments

You use a certain level of the exchange rate when pricing your products

You want to be able to drop the contract and take advantage of a favorable exchange
rate movement if this happens
The CALL option gives its buyer the right and not the obligation to buy a specific amount of
currency at a pre-established rate in exchange of a premium paid (the cost of the option).
The PUT option gives its buyer the right and not the obligation to sell a specific amount of
currency at a pre-established rate in exchange of a premium paid (the cost of the option).
A large series of complex products can be obtained on the basis of these two types of vanilla
options in order to build-up a product that is most suitable for your companys foreign exchange
risk hedging needs.
(d) Currency Swaps
A currency swap transaction represent an agreement to exchange one currency for another at
an agreed upon exchange rate. There are two simultaneous transactions, one of buying and

one of selling the same amount at two different value dates (usually SPOT and FORWARD) and
at exchange rates (SPOT and FORWARD) that are pre-agreed at the moment when the
transaction is closed.
In a currency swap, the holder of an unwanted currency exchanges that currency for an
equivalent amount of another currency. Thus, the client exchanges his interest and currency
rate exposures from one currency to another or benefits of bank financing at a lower rate.