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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.

Hedging Special Interest Group

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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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