Hedging an existing exposure
A business or investor may use a derivative to offset part of an existing risk. For example, a future currency receipt can create uncertainty about its value in another currency. A related contract may reduce that uncertainty, but the hedge depends on the amounts, dates and references matching the real exposure. A position called a hedge is not automatically protective if it is oversized, expires too early or follows a different price.
Taking or reshaping exposure
Derivatives can also be used to express a view, change the timing of cash flows or obtain an exposure without owning the underlying asset. The convenience of a contract does not remove its obligations. Compare notional exposure with the amount initially paid or posted as collateral, and ask what could require additional cash. An attractive initial cost can obscure a much larger economic sensitivity to changes in price or rates.
Evaluate the whole position
Assess the derivative together with the asset or liability it is intended to affect. Include costs, collateral demands, settlement timing and the possibility of counterparty failure. A hedge can reduce one type of uncertainty while introducing another, such as liquidity risk from a margin call. Keep the purpose and expected cash flows documented so later changes can be judged against the original objective rather than against a single favorable or unfavorable market move.