1.10 HEDGING INSTRUMENTS:
A hedging instrument is a designated financial instrument whose fair value or related cash flows should offset changes in the fair value or cash flows of designed hedged items. A hedged item is an asset, liability, commitment, highly probable transaction, or investment in a foreign operation that exposes an entity to changes in fair value or cash flows, and is designed as being hedged. Most effective hedging instruments are future and option.  Futures:
A future is a contract to buy or sell the underlying asset for a specific price at a determined time. Now investors can trade in index and stock futures on the NSE. In futures trading, investor take buy or sell positions in index or shares contracts having a longer …show more content…
For this, the buyer has to pay to the seller some money, which is called premium. There is no obligation on the buyer to complete the transaction if the price is not favorable to him. To take the buy or sell position on index or shares options, investors have to place certain percentage of order value as margin. With options trading, investors can leverage on investor trading limit by taking buy or sell positions much more than what investors could have taken in cash …show more content…
The risk can be eliminated from a portfolio through diversification. The unsystematic or unique risk affecting specific securities arises from two sources:
 The operating environment of the company
 The financing pattern adopted by the company.

1.14 HEDGING DECISIONS:
An important issue for multinational firms is the allocation of capital among different countries production and sales and at same time hedging their exposure to the varying exchange rates. Research in this area suggests that the elements of exchange rate uncertainty and the attitude toward risk are irrelevant to the multinational firm’s sales and production decisions. Only the revenue function and cost of production are to be assessed, and, the production and trade decisions in multiple countries are independent of the hedging decision.
The implication of this independence is that the presence of markets for hedging instruments greatly reduces the complexity involved in a firm’s decision making as it can separate production and sales functions from the finance function. The firm avoids the need to form expectations about future exchange rates and information of risk preferences which entails high information