Final answer:
A company can reduce financial exposures through options, swaps, futures, and forwards, which are instruments used for hedging currency risks. Considerations for investors include the costs and benefits of hedging compared to potential risks and exposures. Financial institutions typically aid in executing these contracts, often for a fee.
Step-by-step explanation:
A company can use a variety of financial instruments to reduce financial exposures, such as currency risks from contracts that may vary due to exchange rate fluctuations. These instruments include: options, swaps, futures, and forwards. Hedging, which is essentially taking a position in a financial transaction to offset the risk in another investment, can be used to lock in a certain exchange rate. Financial institutions or brokerage companies may facilitate these transactions for a fee or by creating a spread in the exchange rate. Additionally, companies must consider whether to access financial capital by borrowing from banks, issuing bonds, or selling stock, each with its own advantages and risks.
When analyzing the risk involved in different types of financial assets, it is crucial to understand how these instruments can serve as protection against potential losses. For options, swaps, futures, and forwards, their specific characteristics need to be evaluated in light of the company's unique financial situation and the nature of its exposure. The key considerations for investors include the cost of the hedging contract, the potential to give up gains if the hedged asset moves in a favorable direction, and the degree of certainty it provides against unfavorable movements.