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natural currency hedging

Natural currency hedging refers to a hedging technique that does not require the use of financial derivatives. For example, a holding company with subsidiaries can seek to maintain equal amounts of receivables and payables denominated in a foreign currency.

To undertake natural currency hedging, a firm with FX-denominated receivables could borrow short-term in that currency. When translated into the firm’s functional currency, the depreciation (appreciation) of the foreign currency would result in a loss (gain) in the value of the receivables, but in a lower (higher) value of the liabilities as well.

While theoretically attractive —because of the implied lower transaction costs that it entails—, natural hedging is much less precise than hedging with forward contracts. Besides, such a technique may not be always fully ‘natural’ but forced, i.e. the company would end up subordinating business decisions to risk management decisions.