Introduction
Exposure netting is the offsetting of exposure in one type of currency with exposure in the same or another type of currency. The objective of this is to protect against exchange rate risks.
The gains or losses from the first exposure can be offset against the gains or losses from the second exposure. In simple words, it is a method of hedging currency risks.
Exposure netting is usually carried out by large companies who deal with a huge number of international clients. As it is not possible to hedge each and every client's currency risks individually, all currencies exposure can be managed as a single portfolio.
Benefits of Exposure Netting
- Exposure netting helps the holistic management of a company's currency risks.
- Due to this process, various currencies can be managed under a single portfolio, thus saving costs and time involved in hedging each currency risk.
- It eases risk management for the company as a whole, especially large corporations with a high volume of international transactions.
How Does Exposure Netting Work?
Here is an example of how exposure netting works. A US company has exported machinery to a company in Spain for 1.85 million Euro ($2 million USD). The US company manufactures its machinery in India and owes its supplier Rs.7 crore ($1 million USD), which needs to be paid in two months' time.
The US company’s exposure is $3 million USD ($2 million USD + $1 million USD). If the US company is aware that the USD will appreciate over the next two months for sure, it will not need to hedge the risk, as the Euro will become cheaper. However, if the company fears that the USD will depreciate against the Euro, it will need to hedge the risk, by locking in the exchange rate through a forward contract.
