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Hedge

A hedge is a risk management strategy used by investors and businesses to protect against potential losses in an investment or asset. Hedging involves taking an offsetting position in a related security, asset, or derivative to reduce exposure to unfavorable price movements. Common hedging instruments include options, futures, and forward contracts. While hedging can reduce risk, it may also limit potential gains if the market moves in a favorable direction.

Example

A wheat farmer enters into a futures contract to sell wheat at a fixed price, hedging against the risk of price declines during the harvest season.

Key points

• Risk management strategy that offsets potential losses.

• Involves using derivatives like options and futures.

• Can limit both risk and potential gains.

Quick Answers to Curious Questions

Investors hedge to protect against adverse market movements and minimize the risk of financial losses in their portfolios.

Hedging can reduce potential profits if the market moves in a favorable direction, and it may involve additional costs such as premiums for options.

Investors can hedge stock positions by buying put options, which increase in value if the stock price declines, offsetting losses from the stock itself.