Final answer:
Significant portions of the Energy Trading portfolio can be economically hedged to mitigate risk by using financial transactions to protect against potential losses. Hedging contracts guarantee a fixed exchange rate in the future, reducing the impact of currency fluctuations. Financial institutions or brokerage companies often handle hedging transactions and charge a fee for their services.
Step-by-step explanation:
Significant portions of the Energy Trading portfolio can be economically hedged to mitigate risk. Hedging is a financial transaction that protects against potential losses. In the case of currency risk, a firm can sign a contract to guarantee a certain exchange rate in the future, regardless of market fluctuations. This ensures that the firm will receive a fixed amount of currency regardless of exchange rate movements, providing stability and reducing potential losses.
For example, if a U.S. firm is exporting products to France and will receive 1 million euros a year from now, they can enter into a hedging contract that guarantees a specific exchange rate between the euro and the dollar. If the euro declines in value, the firm is protected by the hedge and will still receive the agreed upon amount of dollars. However, if the euro increases in value, the firm may have paid a fee for unnecessary hedging.
In order to hedge, parties typically rely on financial institutions or brokerage companies to handle the transactions, who may charge a fee or create a spread in the exchange rate to earn money.