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Hedging is all about to minimise the risk,for example an oil export company knows that they will give delivery 200 barrel of crudeoil to India after 2 month and the prices of crudeoil has to fixed now itself i.e. $55 per Barrel.during this 2 month prices of crude may varry from present price so there will a price risk for the export Company so to reduse or else to minimise the risk they can take the buying position in derivative contracts for 2 months which is available in commodity derivative Market.so if in case any price fluctuate in crude prices they may loss in spot market but in derivate they will be profit and vice versa.
Hedging is buying insurance for your position in your portfolio. It is taking the opposite position to safeguard and book your downside risk knowing that it doesn't lead to best outcome but rather to a certain outcome. There are financial instruments like derivatives that are available to hedge your position.
e.g. If a company is doing business in a foreign country and is skeptical about the foreign currency depreciating for it will lead to receiving fewer home currencies, it should hedge its downside exposure by taking an offsetting position to the position it has already taken. Thus, derivatives instruments like options, swaps, forward and/or futures can be used. However, swaps represents the best financial instrument since it covers the whole notional amount and it can result to a favorable outcome to all the parties involved.
