Futures hedging
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The following is a question I answered that came up short, I think probable I should have looked at it from a short position:
1. Explain how futures contracts could be used to hedge a bond portfolio against the risk of rising interest rates. Then explain how futures could be used by both exporters (due to receive foreign currencies) and importers (due to pay in foreign currencies) to hedge against their foreign-exchange exposure.
A bond portfolio can be hedged against the risk of rising interest rates by using an interest rate futures contract to partially or totally reduce interest rate risk without disturbing the underlying asset.
An importer would hedge against foreign-exchange exposure by buying a sufficient number of futures contracts to create a hedge. The importer would then sell the contracts at maturity and take delivery of the foreign currency. The foreign currency received from the contracts would pay for the imports.
An exporter would hedge against foreign-exchange exposure by buying futures contracts to offset changes in exchange rates while waiting to receive foreign currencies.
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This discusses the concepts related to futures hedging
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Discussion of Basic concepts
Risk is the uncertainty that you may not earn your expected return on your investments. For example, you may expect to earn 20% on your stock mutual fund every year. But your actual rate of return may be much lower. Multinational firms must constantly assess the business environments of the countries they are already operating in as well as the ones they are considering investing in. One of the most important international risks, which an organization faces, is exchange rate risk.
Exchange Rate Risk
Organization which invest internationally in today's increasingly global investment arena face the prospect of uncertainty in the returns after they convert the foreign gains back to their own currency. Unlike the past when most U.S. investors ignored international investing alternatives, investors today must recognize and understand exchange rate risk, which can be defined as the variability in returns on securities caused by currency fluctuations. Exchange rate risk is sometimes called currency risk.
Transaction exposure arises ...
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