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Anonymous

18 Nov 2019

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General Investing

What is a natural hedge? Why are futures used as a natural hedge?

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Kelly Trinh

18 Nov 2019

Backoffice technical at financial services firm

A natural hedge is where you can neutralize (hedge) a risk through arranging an (investment/business) in a certain way instead of resorting to financial instruments.

Eg. a mobile phone manufacturer has operations in China and exposed to FX risk on cost of production. By selling some of the output to China market then proceeds can cover cost of production and hence naturally hedge the FX risk.

Natural hedge is a reduction in foreign exchange (forex) risk employed through changes in a company's operating procedures.

Take for example an automobile company. To reduce forex risk, they would choose to buy raw metals locally rather than from abroad (unless there is significant price advantage).

Futures allow for predicatable expenditures.

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