The hedge is the financial terms used in risk management strategy. It is the offsetting or limiting the probability of loss from the decreasing prices of the stock, commodities, currencies and securities. In other word, It is the process of transferring risk without buying insurance policy.
In simple language, It is the process of making investment in a way to reduce the adverse the price movement in stock, commodities, currencies and securities. The best example of it is future contracts in which, an investor is in an offsetting position in a related securities. Perfect hedge reduce the risk of investor without any opportunity cost except the cost of the hedge itself.
Example of Hedge
An investor buys a stock and want to avoid the fluctuations of price in a stock then sold a future contract stating that he would sell stock at a set price. By this way, he can avoid market fluctuations.
Hedge as a risk management strategy is used when the investor is;
- Unsure about the market situation and
- Unwilling to face risks.
Hedging has various technique prevailing in the market. Perhaps, the basic technique is to take equal and opposite positions in two different markets, for example Cash and Future markets.