Ahedgeis 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 HEDGINGSHORTHEDGING 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 exchangemarket. It is theover-the-counter marketin which the foreign currencies of the world are traded. It is considered the largest and mostliquid marketin the world.

How it works/Example:Foreign Exchangehas no centralizedmarket. Instead, a foreign exchange market exists wherever the trade of two foreign currencies are taking place. It isopen24 hours a day, five days a week. This foreign exchange market exists to easeinvestmentand 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 andinvestmentwould 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 aclearinghouseto trade those major currencies.characteristics: its huge trading volume representing the largest asset class in the world leading to highliquidity; its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e., trading from 22:00GMTon Sunday (Sydney) until 22:00 GMT Friday (New York); the variety of factors that affectexchange rates; the low margins of relative profit compared with other markets of fixed income; and the use ofleverageto enhance profit and loss margins and with respect to account size.Historically, only largefinancial institutions, corporations,central banks,hedge fundsand 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 sellcurrencieswith 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.RankNameMarket share

1Citi16.04%

2Deutsche Bank15.67%

3Barclays Investment Bank10.91%

4UBS AG10.88%

5HSBC7.12%

6JPMorgan5.55%

7Bank of America Merrill Lynch4.38%

8Royal Bank of Scotland3.25%

9BNP Paribas3.10%

10Goldman Sachs2.53%

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 'FOREIGN-EXCHANGE 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 HEDGEForeign exchange risk(also known asFX risk,exchange rate riskorcurrency risk) is afinancial riskthat exists when a financial transaction is denominated in acurrencyother 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 theexchange rateof 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 contractsThe 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 anteThis 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 transactionsA 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 paymentsThis 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 OptionsFX Options give their buyer the right but not the obligation to sell/buy a specific amount at a pre-agreed 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 movementThis 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 happensThe 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 SwapsA 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.