Forex glossary
Hedging
Hedging reduces a specified exposure through a transaction or instrument with an offsetting effect, such as a forward for a future payment. Effectiveness depends on amount, timing and the relationship between positions; costs, basis risk and counterparty risk may remain.
Illustrative example
How does it work in practice?
Suppose an importer owes 10,000 EUR in one month and agrees a matching deliverable forward at 4.30 PLN per EUR. The outflow is fixed at 43,000 PLN before fees; counterparty risk remains.
A case to work through
A hedge for part of an invoice
Model: 12,000 EUR is due in one month; a forward covers 9,000 EUR for the same date.
- Coverage is 9,000/12,000 = 75%.
- The remaining 3,000 EUR still depends on the future exchange rate.
What follows? Assess residual exposure together with contractual costs.
Example boundary: This omits counterparty risk and changes to the actual payment amount.
Covered and remaining amounts
Text description of the diagram
- Payment: 12,000 EUR.
- Forward: 9,000 EUR for the same date.
- Residual exposure: 3,000 EUR, or 25%.
A useful distinction
Hedging / Diversification
Diversification spreads exposures; a hedge offsets a particular exposure.
Check your understanding
Calculate the unhedged portion of a future payment.
Show the answer and explanation
5,000 EUR
15,000 − 10,000 = 5,000.
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Related terms
Sources and documentation
- BCBS/BIS: Foreign exchange risks — Basel Consolidated Guidelines, RMA20
The guidelines define a wholesale FX swap as a currency exchange combined with a reverse exchange with the same counterparty at a later date.
Document read: - BIS MAR10: market risk terminology
VaR at a stated horizon/confidence and expected shortfall as a tail mean.
Document read:
The example illustrates the mechanism. Check current account conditions and instrument specifications with the provider.