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- Financial risk hedging types
- Financial risk hedging methods

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Financial risk hedging types

Let's look at the types of financial risk hedges:

  • Hedging using options.

    This variety makes it possible not to be afraid of financial risks during transactions with securities, currency, real assets. To do this, a transaction with a premium (option) is used, the latter is paid for the right to sell/buy a security, currency in a conditional amount and at the agreed price within the prescribed period.

    There are three ways to reduce risks with options, where everything happens based on:
    -purchase option, which gives the right to purchase at the agreed price;
    -a sales option that allows sale at an agreed price;
    -a double option giving the right to purchase and sell the relevant instrument at the agreed price.

  • Hedging using futures contracts.

    Futures contracts are fixed-term transactions concluded on exchanges for the purchase and sale of raw materials, gold, currency, securities at prices valid at the time of the transaction, with the supply of the purchased goods and their payment in the future. It is possible to avoid financial risks in this case: if a company incurs losses due to price changes at the time of delivery as a seller of currency or securities, then it wins no less as a buyer of futures contracts for the same amount of currency or securities, and vice versa.

    You can open an exchange (futures, options) contract only on the exchange, since a third party, namely the Clearing House, is necessarily involved in the transaction. It is the guarantor of the parties' performance of their obligations. Contracts are considered independent derivative financial assets and subject to purchase/sale.
    Pluses: security, free access to trading, high market liquidity.
    Minuses: standardized assets, stringent requirements, transaction restrictions.

    OTC (forwards, options) contracts are concluded outside the exchange. This happens directly or with the participation of an intermediary, such documents are of a one-time nature, do not apply to the market, cannot be used as independent traded assets.
    Pluses: maximum flexibility when selecting an asset type and contract terms (quantities, prices, dates, parameters).
    Minuses: low liquidity (self-search for a counterparty), high risks of default and transaction costs.

  • Hedging using the swap transaction.

    Swap is the name of a trade and financial exchange transaction in which the signing of a transaction on the purchase/sale of securities, currency takes place in parallel with the conclusion of a counter-transaction. The second is a transaction for the reverse sale/purchase of the same financial instrument after a certain period on similar or new terms.

    There are several swap transactions:
    -in order to extend the validity period of securities due to their sale and simultaneous purchase of the same type of securities having a longer validity period.
    -currency swap transaction, i.e. purchase of foreign currency with immediate payment in local currency subject to repurchase in the future.
    -the interest swap transaction assumes that one party (lender) is obliged to pay the other interest received from the borrower at the libor rate in exchange for repayment at a fixed rate. Let us explain that we are talking about the rate on short-term loans provided by London banks to other first-class banks.