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Introduction
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Organisations use financial instruments to offset potential losses that may be incurred in the future. Different instruments are used for different situations, but all have the purpose to minimise future losses and/or covering the current situation of a company.
Examples of financial instruments used by companies to minimise risk include:
- Stocks
- Exchange-traded funds
- Insurance
- Bonds
- Annuities
- Forward contracts
- Options
- Future contracts
The term hedging refers to the act of reducing a firm’s exposure to a price or rate fluctuations.
Public futures markets were established in the 19th century to allow transparent, standardised and efficient hedging of agricultural commodities such as grains, metals, gas, electricity and oil prices; they have since expanded to include futures contracts for hedging the value of energy, precious metals, foreign currency and interest rate fluctuations.
The calculations with regards to hedging instruments are normally done by financial experts in a business or even by actuaries. We will however for the purpose of this unit standard explain the calculations for the forward contract for currencies (simple form of options and futures).
