Definition
Natural Hedge
A natural hedge offsets currency risk through the structure of a business itself, such as matching foreign-currency revenues with foreign-currency costs, rather than using derivatives.
An Indian auto-parts firm that exports to the US and also imports components priced in dollars has a partial natural hedge: dollar inflows fund dollar outflows, shrinking net exposure. Only the residual needs financial hedging.
Companies create natural hedges by borrowing in the currency they earn or sourcing inputs in their billing currency. It costs nothing in premiums but is limited by how well revenue and cost currencies actually match, so most firms combine it with forwards or options.
Related terms
- Currency Swap (FX Swap)An FX swap is a simultaneous agreement to buy a currency at the spot rate and sell it back at a forward rate (or vice versa), used to manage short-term funding and liquidity.
- Hedging Forex RiskHedging forex risk means using forwards, futures, options or swaps to lock in or limit the exchange-rate cost of future foreign-currency cash flows.
- Translation ExposureTranslation exposure is the accounting impact on a company's consolidated financials when foreign-currency assets, liabilities and earnings are converted into the reporting currency.
- External Commercial Borrowing (ECB)External commercial borrowings are foreign-currency or rupee loans raised by eligible Indian companies from non-resident lenders under RBI's framework, subject to cost and end-use limits.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.