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What is a Hedge? Meaning.

A Hedge is the purchase or sale of a Call Option, Put Option or Futures Contract as a temporary substitute for a transaction to be made at a later date. The purpose of a hedge is to avoid or minimize exposure to an unwanted business risk, by purchasing on both sides of a risk, so that any loss in one security is countered by gains in the other securities. A hedge can be seen as some kind of Portfolio Insurance.

Usually it involves the initiation of a position in a futures or options market that is intended as a temporary substitute for the sale or purchase of the actual commodity.

Typical Risks that are hedged are: Interest Risk, Equity Risk, Credit Risk and Forex Risk.

What is Hedging? Meaning.

Hedging is the process of protecting a company against unwanted risk. For example, a firm who owes money to an overseas corporation may want to hedge against the risk that the exchange rate moves against them. They could do this by taking out a future contract for foreign exchange. In other words they agree to buy now at a fixed price in the future.

Some form of risk taking is inherent to any business activity (if there were no risk, it is likely there would be no reward). Some forms of risk are "natural" to a business, whose competitive advantage is to manage the risk well, i.e. to minimize the costs of the risk, against the profit it is likely to achieve. Other forms of risk are not wanted, but cannot, as things stand, be avoided. Hedging consists of selling off the unwanted risk to those who have the ability or desire to take it. Typical examples of risks that are often hedged are: insurance risks, credit risks and foreign exchange risks.

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🔥 NEW Types and Applications of Derivative Products
The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncert...
Hedging and Transfer Pricing
What is the relationship between hedging and transfer pricing?...

Best Practices

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Expert Tips

Advanced insights about Hedging. Here you will find professional advices by experts.

Alternatives to LIBOR - Key Challenges for Transition to Risk Free Rates

Inter-bank Offered Rate, LIBOR, SOFR, SONIA, ESTER, SARON, TONAR
London Inter-bank Offered Rate (LIBOR) is the rate at which a bank can borrow funds. It is an interest-rate average calc...
Information Sources

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Overview of Hedge Fund Investment Strategies

Hedge Funds, Hedging, Investment Strategies
Presentation about Hedging, introducing many terms and strategies: 1. Hedge Funds Investment Strategies 2. Four Groups...

Financial Derivatives: an Overview

Hedge Funds, Financial Derivatives, Investment Strategy
This presentation provides an overview of different types of financial derivatives and about Hedge Funds. The presentati...

Introduction and Summary of Interest Rate Swap

Initial Understanding of Interest Rate Swap
Explanation of Base Rate Swaps. A swap is an instrument that allows you to exchange a variable rate of a loan (that is ...

Introduction and Summary of Hedging

Initial Understanding of Hedging, Trainings, Workshops
Explaination of hedging using futures contracts within the context of the London Metal Exchange (LME), thus avoiding liq...

Introduction and Summary of Futures and Stop Loss Contracts

Initial understanding of Futures and Stop Loss Contracts
A derivative is a financial contract which derives its value from the performance of another entity such as an asset, in...

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Compare also: Strategic Risk Management  |  Portfolio Insurance  |  Non-Systemic Risk  |  Systemic Risk  |  American-Style Option  |  European-Style Option  |  Call Option  |  Put Option  |  Asian Option  |  Futures Contract  |  Short Selling

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