Question

Explain the difference between “net” and “gross” currency exposures.  Why is the difference important in managing foreign exchange risk?  What is a natural hedge?

Answer 1

Gross currency exposure is the currency risk remaining in a trade after positions or cash flows in each currency contract have not been netted out.
Net currency exposure is the currency risk remaining in a trade after positions or cash flows in each currency contract have been netted out.
For example,
If there is a currency contract that involves 3 long positions and 2 short positions then this would be called a gross currency exposure.
And, if this is netted out to one long position then this is called a net currency exposure.

Netting out positions helps a trader calculate the ultimate profit/loss occurring in that particular trade which further is helpful in setting up positions to manage risk as for risk exposures, offsetting positions do not need to be individually hedged. This also reduces firm's cost and time and this is why the difference in gross and net currency risk exposure is important in managing foreign exchange risk.

Natural Hedge is a strategy to manage risk by investing in securities that are negatively correlated with each other.
A company can employ a natural hedge if it is able to incur expenses and generate revenue in the same currency. This lowers the exchange rate risk.