What Is Hedging Currency Risk?

Risk hedging refers to a risk management strategy to offset the potential risk loss of the underlying asset by investing in or purchasing a certain type of asset or derivative product that is negatively related to fluctuations in the return of the underlying asset. Risk hedging is a very effective way to manage interest rate risk, exchange rate risk, stock risk, and commodity risk. Unlike the risk diversification strategy, risk hedging can manage systemic and non-systematic risks. It can also reduce risks to expected levels through the adjustment of hedging ratios based on investors' risk tolerance and preferences. The key issue of using risk hedging strategies to manage risk is to determine the hedging ratio, which is directly related to the effect and cost of risk management.

Risk hedging

Risk hedging refers to

Risk Hedging is Management

Risk hedging must design a risk combination instead of a single risk. For a single risk, only risk aversion and risk control can be performed.

Such as the use of asset portfolios, settlement and use of multiple currencies, strategic diversification, and so on. ^[1]

If you buy a stock at the price of 10 yuan, this stock may rise to 15 yuan in the future, or it may fall to 7 yuan. Your expectations for earnings are not too high, and the main thing is that you do not want to lose as much as 30% if the stock falls. What can you do to reduce the risk of a stock falling?

One possible solution is: you buy a put option on this stock at the same time you buy the stock-an option is a right (not an obligation) that can be exercised in the future. For example, a put option here might be " The right to sell the stock at a price of 9 yuan a month "; if the stock price is less than 9 yuan a month later, you can still sell it for 9 yuan, and the issuer of the option must fully collect the order; At 9 yuan, you will not exercise this right (would it be better to sell a higher price in the market). Given this optional right, the issuer of the option will charge you a certain fee, which is the option fee.

Originally your stock might bring you 50% gain or 30% loss. When you buy a put option with a strike price of 9 yuan at the same time, the profit and loss situation changes: the possible return becomes.

(15 yuan-10 yuan-option fee) / 10 yuan ^[1]

The possible loss becomes:

(10 yuan-9 yuan + option fee) / 10 yuan

The potential gains and losses have been reduced. By buying put options, you pay a portion of the potential gains in exchange for risk aversion.