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Hedging risk is a very important topic in recent years. Many banks, companies, and agencies have...

Hedging risk is a very important topic in recent years. Many banks, companies, and agencies have tried utilizing this strategy to various degrees of success. For a company to reduce its risk by following hedging strategies, another company must be willing to assume that risk. This is called speculating. Find at least one example of a hedging strategy and explain who the speculator is and what risk they are assuming.

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Expert Solution

One example of hedging strategy would be-

When there would be a multinational company who is exporting into another country. let's say there is an American company who is exporting into India. This company have receivables in Indian rupee in next 3 months. This company will be exposed to risk related to foreign exchange fluctuations because it is exporting to another country. This risk is basically known as transaction risk.

This company will be exposed to depreciation in Indian rupee because the receivables of this company is in Indian rupees so this company will be trying to enter into a forward contract with another party in order to hedge itself from fluctuation in foreign currency so it will be fixing the rate of its receivables after 3 months by entering into a forward contract and it will be gaining the exact amount even after the value of Indian rupee will be depreciating against American Dollars.

This type of risk is known as transaction risk and this has been hedged through forward contracts in the derivative markets, which is a customised contract and which will be having counterparty risk. Speculator in this case will be another party with which forward contract is entered into and he is is trying to gain over any fluctuation in American Dollars over Indian rupees.

jeff jeffy answered 2 years ago
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