hedging sherrie

8/2/2019 HEDGING Sherrie

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By- Sherriegale Cardozo

Roll No: 04-2010


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DEFINITION OF HEDGING

A risk management strategy used in limiting or offsetting

probability of loss from fluctuations in the prices of

commodities, currencies or securities. In effect, HEDGING isa transfer of risk without buying insurance policies.


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WHO ARE HEDGERS??? Aninvestor who takes steps to reduce the risk of

an investment by making an offsettinginvestment.

Overall, hedgers are seen as risk averse and speculators aretypically seen as risk lovers. Hedgers try to reduce the risksassociated with uncertainty, while speculators bet against themovements of the market to try to profit from fluctuations inthe price of securities.

For example, a cereal manufacturer may want to hedge againstrising wheat prices by buying a futures contract that promisesdelivery of September wheat at a specified price.

If, in August, the crop is destroyed, and the spot price increases,

the manufacturer can take delivery of the wheat at the contractprice, which will probably be lower than the market price. Or themanufacturer can trade the contract for more than the purchaseprice and use the extra cash to offset the higher spot price ofwheat.
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HOW DOES HEDGING WORK?

In hedging, a buyer who requires a commodity ata future date protects himself from the risk of a

possible price rise, by agreeing to buy the same

commodity at a pre-determined price.

Alternatively, a seller who plans to sell acommodity at a future date but fears a potential

price fall can agree to sell the same commodity at

a pre-determined price.

Thus, both buyer and seller can use the hedging

mechanism to obtain protection from adverse

price movements.


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IS HEDGING RISKY?

Hedging is generally not considered risky if it isbased on covering short-term requirements.

However, if the hedging party places a wrong bet,

then they may miss out on potential savings. For instance, if a copper manufacturer has a

capacity of 200 tonne and decides to sell 300tonne on the futures exchange the remaining 100

tonne is considered as speculation in the market. If prices fall then he stands to benefit, however if

prices go up the 200 tonne he produces can bedelivered on the exchange but he would have to

incur losses on the additional 100 tonne.


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SHORT HEDGE

A short hedge requires the investor to take a short position

in the futures market.

A person may go in for a short hedge if he already has the

asset in his possession and expects to sell it at some time in

the future. Such a hedge is called an INVENTORY HEDGE.

It works as follows, if the price in the spot market were to

decline, he can still sell at the original futures price, since the

other party is under an obligation to buy at this price.


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For example:


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LONG HEDGE

o Is also known as BUYING HEDGE.

o It requires the hedger to take a

long position in the futuresmarket.

o A person who needs to acquire

an asset in the future and isconcerned that the price will rise,

will go in for such a hedge.


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EXAMPLE OF LONG HEDGE


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HEDGING IN THE CASE OF IMPORTER


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HEDGING IN THE CASE OF EXPORTER


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HEDGING IN THE CASE OF MONEY

MARKET

Firms which have access to international

money markets for short-term borrowing as

well as investment, can use the money marketfor hedging transactions exposure.

For example:


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HEDGING IN THE CASE OF

COMMODITIES MARKET

hedging sherrie

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