Exposure Netting

Definition of 'Exposure Netting '


A method of hedging currency risk by offsetting exposure in one currency with exposure in the same or another currency. Exposure netting has the objective of reducing a company’s vulnerability to exchange rate risk. It is especially applicable in the case of a large company, whose various currency exposures would be managed as a single portfolio, since it would be infeasible and impractical to hedge each and every currency exposure individually. A firm’s exposure netting strategy depends on a number of factors, including the currencies and amounts involved in its payments and receipts, the corporate policy with regard to hedging currency risk, the correlations between the different currencies to which it has exposure, etc.

Investopedia explains 'Exposure Netting '


If the correlation between exposure currencies is positive, a company would adopt a long-short strategy for exposure netting. This is because, with a positive correlation between two currencies, a long-short approach would result in gains from one currency position offsetting losses from the other. Conversely, if the correlation is negative, a long-long strategy would result in an effective hedge in the event of currency movement.

Assume Widget Co, located in Canada, has imported machinery from the United States and regularly exports to Europe. The company has to pay $10 million to its U.S. machinery supplier in three months, at which time it is also expecting a receipt of EUR 5 million and CHF 1 million for its exports. The spot rate is EUR 1 = USD 1.35 and USD 1 = CHF 1.10. How can Widget Co. use exposure netting to hedge itself?

The company’s net currency exposure is USD 2.15 million (i.e. USD 10 million – [(5 x 1.35) + (1 x 1.10)]. If Widget Co. is confident that the Canadian dollar will appreciate over the next three months, it would do nothing, since a stronger Canadian dollar would result in U.S. dollars becoming cheaper in three months. On the other hand, if the company is concerned the Canadian dollar may depreciate against the U.S. dollar, it may elect to lock in its exchange rate in three months through a forward contract or a currency option. Exposure netting is thus a more efficient way of managing currency exposure by viewing it as a portfolio, rather than hedging each currency exposure separately.



comments powered by Disqus
Hot Definitions
  1. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  2. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  3. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  4. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  5. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
  6. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
Trading Center