Hedging

A hedge is an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/gains suffered by an individual or an organization.

A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts.

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. The word hedge is from Old English hecg, originally any fence, living or artificial. The use of the word as a verb in the sense of "dodge, evade" is first recorded in the 1590s; that of insure oneself against loss, as in a bet, is from 1670s.

There are varying types of risk that can be protected against with a hedge. Those types of risks include:

Commodity risk: the risk that arises from potential movements in the value of commodity contracts, which include agricultural products, metals, and energy products.

Credit risk: the risk that money owing will not be paid by an obligor. Since credit risk is the natural business of banks, but an unwanted risk for commercial traders, an early market developed between banks and traders that involved selling obligations at a discounted rate.

Currency risk is used both by financial investors to deflect the risks they encounter when investing abroad and by non-financial actors in the global economy for whom multi-currency activities are a necessary evil rather than a desired state of exposure.

Interest rate risk: the risk that the relative value of an interest-bearing liability, such as a loan or a bond, will worsen due to an interest rate increase. Interest rate risks can be hedged using fixed-income instruments or interest rate swaps.

Equity risk: the risk that one's investments will depreciate because of stock market dynamics causing one to lose money.

Volatility risk: is the threat that an exchange rate movement poses to an investor's portfolio in a foreign currency.

Volumetric risk: the risk that a customer demands more or less of a product than expected.

Ex. 1. Look at the words in italic in each of the following sentences and choose the correct one.

1. We’re setting all the prices for next year except/accept the new range which won’t be ready for another three months.

2. Can you remember /remind him to bring the comparative costs.

3. After the confusion over the bank transaction, they have agreed to waive /wave charges.

4. These two companies have been in collision/ collusion with each other on the price fixing issue.

5. We should use an alternative/ alternate pricing structure to the one we use now.

6. We’ve had an officious/ official letter to tell us about the changes in export regulations.

7. When deciding on new prices you mustn’t lose sight/ site of market behaviour.

8. Once they have agreed the figures we can precede/ proceed with the costing.

9. Please insure/ ensure that only the most recent figures are included in the calculations.

10. When we are setting standards we allow 10% for deficient/ defective goods.

11. There must be a mistake in the calculations somewhere. These figures are just not credible/ creditable.

12. The cash budget must take seasonal/seasonable variations into consideration.

13. The consultant is being prosecuted /persecuted for tax evasion.

14. The management have now decided what measurement/ measures to take to increase productivity.

Text 2. Be ready for a comprehension checkup.