Hedging

Hedging is basically taking a position in the market to reduce the risk. It is a strategy built to reduce the risk in investment using call/put options/futures short selling. The idea of hedging is to reduce the volatility of a portfolio by reducing the potential risk to loss. Hedging especially protects small businesses against catastrophic or extreme risk by protecting the cost at the time of distress. The tax laws also benefit those who do hedging. For firms who do hedging, it works like insurance and they have more independence to make their financial decisions without thinking about the risks.

Now, let us consider some scenarios of hedging:

• Currency risk: Also known as exchange-rate risk, it happens due to fluctuations in the prices of one currency with respect to another. Investors or companies who operate across the world are exposed to currency risk, which may lead to profit and losses. This risk can be reduced by hedging, which can prevent losses happening due to price fluctuation...