Hedge (finance)

The concept of hedging, hedging or hedge transaction ( short hedging, . Engl of to hedge [ hɛdʒ ], " hedge " ) refers to a financial transaction involving the Securing a transaction against risks, such as currency fluctuations or changes in commodity prices. The person or company that wants to hedge a transaction (also called hedgers ), go to this end, a further transaction, coupled with the underlying transaction. This takes place in the form of a forward contract generally. A perfect hedge eliminates any systematic risk, but is almost impossible in practice.

Features

The Hedging is the intention of providing a currently perceived as acceptable price, such as the market price of a security, the exchange rate of a currency or an interest rate set for the future.

Hedging transactions can basically both exchange-traded instruments such as futures and options ( often referred to as portfolio insurance ) as a set also over the counter in so-called over-the -counter markets through non-standardized derivatives.

The success of the hedge transaction is based on an award- balancing effect of price fluctuations of the underlying transaction by an opposing involvement in the futures market. Votes course direction and the magnitude of price changes in spot or cash market and futures market in complete agreement, it can completely be eliminated by taking an opposite position in the futures market uncertainty about the future price of the underlying transaction. Through a parallel movement of the forward rates to the spot or spot rates a market subject to foreign exchange gains and losses equal therefore ideally completely.

We distinguish between inventory hedge and hedge antizipativem. A stock hedge is used to hedge an existing cash position, such as a DAX portfolio. The anticipatory hedge would have received a purchase of the DAX at a future date.

Example

A European company sells products in the United States. It includes a contract today and must end of the year 10,000 pencils for the price of $ 1 per pin supply. At the moment you get per dollar € 1. The seller gets the pins according to the current exchange rate that is € 10,000. If the exchange rate at the end of the year 10% lower (or higher ), ie $ 1 is € 0.90 ( or € 1.10 ) value, the seller receives the equivalent of € 9,000 (or € 11,000 ). This € 1,000 loss (or gain ) originate from fluctuations in exchange rates and have nothing to do with the actual business. This has certain implications of accounting law, which are not further the understanding of the business of interest.

In order to hedge against these fluctuations, there are various possibilities. Two simple examples are presented here:

Safe exchange rate

The company can already receive a fixed exchange rate and therefore redeem certainly a certain amount today.

With the help of futures, the company can already $ 10,000, which it receives at the end of the year to sell at a certain price. This is called a short sale or go short. The price of this futures for U.S. dollars at year-end, for example, 0,99 € per U.S. dollar. By the company sells a corresponding number of contracts, it gets from the store with security € 9,900.

Minimum exchange rate

The company can using options to hedge a minimum exchange rate and therefore a minimum amount with the possibility to increase.

She buys to a corresponding number of contracts with the right at the end of the year $ 10,000 for sale at a price of 0.99 €. This option costs 100 €. If the price of the year at € 1.10, the option expires worthless and the company gets on the market € 11,000 from the sale of pencils. The business brings to the Company, therefore, € 11 000 - € 100 = € 10 900: the money from the sale of pencils, minus the cost of purchasing the option. If the price of the year at € 0.95, the Company shall exercise the right to sell and receive upon exercise of the option € 9,900. The business therefore brings less the cost of the option € 9,800.

As this example illustrates, it is possible to make from uncertain future € 10,000 € 9,900 Today's either safe or a combination of safe and unsafe future € 9,800 € 10,900 ( or more).

Pros and Cons

Hedging mostly avoids the risk of a financial transaction, but on the other hand reduces the yield prospects for a favorable development. Furthermore, can arise for hedge extra cost. Therefore, a hedge by hedging is useful Not every business. In each case, to find a compromise between expected return and acceptable risk. In general, hedging is not useful if the additional hedging costs are higher than the expected return from the hedged financial business.

In addition, the hedging of transactions on the futures markets is a complex process and connected for beginners with additional risks. An example from the past is the great loss of Metallgesellschaft ( now GEA Group), which originated from a lack of understanding of the receipt of hedging positions in the oil futures market.

An alternative to hedging may be to reduce the volatility of an investment portfolio through diversification.

Critical to the meaningful in itself Hedging is argued that on the one hand and the hedged risk will be passed and it is ultimately a partner definitely had to accept ( Hot - Potato -trading). The hedging transactions to deceive others in the inflation of the circuits on the financial markets and would become independent in relation to the real economy.

However, shops mutual protection possible ( "win- win" situation ), namely when two market participants benefit from each opposing development of a course. Thus, for example, a commodity producer and commodity buyers can mutually hedge using a forward contract: If the commodity price, the means for the producer profits and is favorable for the buyer; the price goes up, but it is exactly the opposite. By the securities transaction if the parties can assure a fixed price, so that for both, although the chance of additional income, but also in particular the risk of loss is reduced. A similar mutual hedging is (as just shown), even when the exchange rate risks conceivable, for example, if the buyer and seller of a commodity are domiciled in different states, respectively. The organization of such a transaction on an exchange-traded securities, such as a futures makes this easier to find a contractor and complete the contract at low cost.

However, a pure speculation with the aim of making a profit is about the same instruments used for risk hedging is possible. A large proportion of shares traded on the stock exchanges of derivatives used for speculation. This affects the price formation and may lead to speculative bubbles.