Thread by @yinkanubi

I was having a mini training for members of my team and I asked a senior member to explain to a Newbie what “Hedging” means. The senior one went on and on explaining FX risk and LC contracts such that even I was confused. I decided to make it simpler. This was the convo. Enjoy!

Me - Hedging is like sleeping with a beautiful girl. Every time you do so, she is at risk of getting what?’
Newbie - STD? 😕
Me - 😮 hmmm I was actually thinking of pregnancy. Anyway, Point is, you know there's a risk she cld get pregnant which wld cost you right?
Newbie - Yeah

Me - So what would you do to prevent her from getting pregnant?
Newbie - I could use withdrawal method or a Condom?
Me - Good! But how would you assess the risk of both options?
Newbie - Hmmm ... Withdrawal is 50/50. While condom is above 90%.
Me - Great

Me - In other words, she has a 50% chance of getting pregnant in one option and less than 10% chance in another. What if she get's pregnant either way?
Newbie - Well I will have to consider whether I want to marry her or just care for the baby. Either way, I have bought market

Me - Lol.... So what you've just done is
1. Risk Assessment / Management - Assessing your risk
2. Hedging - Consideration of options to reduce your risk and
3. Risk mitigation - Consideration of options to reduce or lessen the consequences of your risk.
Newbie - Oh Okay

Me - It's the same with FX risk. If u buy a product in which you've to pay (in the future) in FX, the supplier has transferred the FX risk to you. You'll want to reduce the risk of paying at a rate that is higher than your margin right? So what'ld you do?
Newbie - Hedge your risk

Me - Fantastic. You get it. Now we will proceed to see the different options available to us to hedge that risk, like buying forwards, whether they are deliverable or NDFs, funded or unfunded. We'll also compare it with OTC products like futures which are a kind of NDFs...
Newbie