hedging

hedging in commerce, method by which traders use two counterbalancing investment strategies so as to minimize any losses caused by price fluctuations. It is generally used by traders on the commodities market . Typically, hedging involves a trader contracting to buy or sell one particular good at the time of the contract and also to buy or sell the same (or similar) commodity at a later date. In a simple example, a miller may buy wheat that is to be converted into flour. At the same time, the miller will contract to sell an equal amount of wheat, which the miller does not presently own, to another trader. The miller agrees to deliver the second lot of wheat at the time the flour is ready for market and at the price current at the time of the agreement. If the price of wheat declines during the period between the miller's purchase of the grain and the flour's entrance onto the market, there will also be a resulting drop in the price of flour. That loss must be sustained by the miller. However, since the miller has a contract to sell wheat at the older, higher price, the miller makes up for this loss on the flour sale by the gain on the wheat sale. Hedging is also employed by stock and bond traders, export-import traders, and some manufacturers. See also hedge fund .

hedge A financial transaction or position designed to mitigate the risk of other transactions or positions. For example, a manufacturer may contract to sell a large quantity of a product for delivery over the next six months. If the product depends on a raw material that fluctuates in price, and if the manufacturer does not have sufficient raw material in stock, an open position will result. This open position can be hedged by buying the raw material required on a futures contract; if it has to be paid for in a foreign currency the manufacturer's currency needs can be hedged by buying that foreign currency forward or on an option. Operations of this type do not offer total protection because the prices of spot goods and futures do not always move together, but it is possible to reduce the vulnerability of an open position substantially by hedging.

Buying futures or options as a hedge is only one kind of hedging; it is known as long hedging. In short hedging, something is sold to cover a risk. For example, a fund manager may have a large holding of long-term fixed income investments and is worried that an anticipated rise in interest rates will reduce the value of the portfolio. This risk can be hedged by selling interest-rate futures on a financial futures market. If interest rates rise the loss in the value of the portfolio will be offset by the profit made in covering the futures sale at a lower price.

hedge / hej/ • n. a fence or boundary formed by closely growing bushes or shrubs: she was standing barefoot in a corner of the lawn, trimming the hedge. ∎  a contract entered into or asset held as a protection against possible financial loss: inflation hedges such as real estate and gold. ∎  a word or phrase used to allow for additional possibilities or to avoid overprecise commitment, for example, etc., often, usually, or sometimes. • v. [tr.] 1. (often be hedged) surround or bound with a hedge: a garden hedged with yews. ∎  (hedge something in) enclose. 2. limit or qualify (something) by conditions or exceptions: experts usually hedge their predictions, just in case. ∎  [intr.] avoid making a definite decision, statement, or commitment: she hedged around the one question she wanted to ask. 3. protect (one's investment or an investor) against loss by making balancing or compensating contracts or transactions: the company hedged its investment position on the futures market. PHRASES: hedge one's bets avoid committing oneself when faced with a difficult choice.DERIVATIVES: hedg·er n.