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1. Financial risk management - risk response.

Hedging is a risk management technique that generally involves adding an opposite exposure to an existing risk, in the expectation that variations in the two items will cancel out - in whole or in part - to reduce the net variability in the overall hedged position.

Traditionally, hedging referred to using derivative financial instruments (such as forward contracts, futures contracts or options) or other techniques to reduce the impact of fluctuations in such factors as the market price of credit, foreign exchange rates, or commodity prices on its profits or corporate value.

For example, entering a foreign exchange forward contract to sell an expected future foreign currency receipt.

Other techniques include operational or structural responses, for example re-locating manufacturing or assembly to align the currencies of costs with revenues.

Following such successful structuring, the organisation may then be said to be 'naturally' hedged.

Another form of hedging is diversification.

2. Risk management.

The application of hedging techniques was then extended to the management of many other risks including, for example, inflation and longevity risk arising in pension funds.

See also

Treasurer articles