What is "Hedging"?

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Is the position taken in a particular market, in an attempt to offset exposure to price fluctuations in the market in another in order to reduce exposure to risk unwanted. There are many financial constraints to achieve this goal, including insurance policies, futures, barter, Alkhiarat.oukd futures markets was created in 1800 to allow a policy of hedging a transparent and uniform, but has since expanded to include futures contracts to hedge energy values, precious metals, foreign currency and interest rate fluctuations.

Well! to answer the question “what is hedging?” in the general sense, we can imagine a company entering into a transaction whose sensitivity to movements in financial prices offsets the sensitivity of their core business to such changes. Hedging objectives vary widely from firm to firm, even though it appears to be a fairly standard problem. For more explanation , corporations in which individual investors place their money have exposure to fluctuations in all kinds of financial prices as a natural by-product of their operations. These may include foreign exchange rates, interest rates, commodity prices and equity prices. The effect of changes in these prices on reported earnings can be overwhelming, so companies will seek out transactions whose sensitivity to movements in financial prices offsets the sensitivity of their core business to such changes, or hedging. The most sophisticated players in this field recognize that a business’ financial risks present a powerful opportunity to add to their bottom line while shielding the firm from the negative effects of those movements.

In accounting, Hedging is a risk reduction technique whereby an entity uses a derivative or similar instrument to offset future changes in the fair value or cash flows of an asset or liability. A perfect hedge eliminates the risk of a subsequent price movement. A hedged item can be any of the following individually or in a group with similar risk characteristics:

1.    Highly probable forecast transaction

2.    Net investment in a foreign operation

3.    Recognized asset

4.    Recognized liability

5.    Unrecognized firm commitment

Hedge effectiveness is the amount of changes in the fair value or cash flows of a hedged item that are offset by changes in the fair value or cash flows of a hedging instrument. In addition, Hedge accounting involves matching a derivative instrument to a hedged item, and then recognizing gains and losses from both items in the same period.

 

 

 

 

Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment. In simple language, hedging is used to reduce any substantial losses/gains suffered by an individual or an organization. To hedge, the investor takes a stock future position exactly opposite to the stock position. That way, any losses on the stock position will be offset by gains on the future position.

Hedging is a form of insurance through which tools as put and call options are used. It is used when there is uncertanity about the value of the underlying asset in the future. To account for this risk a company sighn a contract with writer that gives the co. the right (not compulsory) to sell the asset at specific rate within or at the end of the agreed period. At the same time the company cab hedge by buying a put option that gives the co. The right to buy the underlying asset at specific rate within or at speciffic date. Therefore, the co. Shall be protected against the asset price volatility. If the mkt price increased the writer can execute the call option. On the contrary if the asset mkt price dropped the co. Shall execute the put option.

What Is Hedging? The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters.

Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another.

Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.

Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge?Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative.

 

an investment position intended to offset losses that may be incurred by a company investment

or used to reduce any  losses suffered by an organization.

Generally speaking, hedging refers to any transaction with the aim to reduce or eliminate expected losses from another (base) transaction.

In its simplest form, a hedge works in the following manner:

If expected loss materializes in base transaction, it is offset (or reduced) by tha gain in hedge transaction. OR

If there is a gain in base transaction, it is offset (or reduced) by the loss in hedge transaction.

For detailed explanation, please see below the answers provided by SHAHZAD Yaqoob and Shameer Nazir Madari..They both have answered very well.

hedging is to eliminate the risk of loss due to price fluctuation. e.g forwards and futures are popular. also the option like call and put are used for it.

Neutral hedge funds are beta neural who are long and short on equity in such a manner that beta exposure is zero.

Hedging is often considered an advanced investing strategy, but the principles of hedging are fairly simple. With the popularity - and accompanying criticism - of hedge funds, the practice of hedging is becoming more widespread. Despite this, it is still not widely understood.

 

Hedging is often unfairly confused with hedge funds. Hedging, whether in your portfolio, your business or anywhere else, is about decreasing or transferring risk. Hedging is a valid strategy that can help protect your portfolio, home and business from uncertainty.

 

As with any risk/reward trade off, hedging results in lower returns than if you "bet the farm" on a volatile investment, but it also lowers the risk of losing your shirt. Many hedge funds, by contrast, take on the risk that people want to transfer away. By taking on this additional risk, they hope to benefit from the accompanying rewards.

 

 

its a risk management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of commodities, currencies, or securities. it is a transfer of risk without buying insurance policies.

Hedging means insurance; it fixes your position in future sales or purchases at fixed price.