Hedging Report?

[Former Member]

Hi all

Can anyone explain me what is Hedging Report?

Hedging Process?

Thanks

Sonali

[Lakshmipathi · Accepted solution]

Dear sonali

"Hedge" means to manage risk. Any given money manager may make an allocation/investment that could be described as speculative; if this same manager simultaneously makes an allocation to an allocation/investment specifically designed to balance or counter-act any negative performance from his speculative position then this would be his hedging position.

There are many types of perceivable risk - Market, Interest rate, Inflation, Sectoral, Regional, Currency, etc. Hedge fund managers utilise the complete arsenal of financial weapons (holding cash, short selling, buying selling or swapping options, futures, commodity and/or currency futures, etc.) and are expert in concocting hedging positions for most conceivable risks.

For more information, check the link

[Market Risk Management |http://help.sap.com/saphelp_46c/helpdata/en/10/d3263713be1c57e10000009b38f936/frameset.htm]

Thanks

G. Lakshmipathi

[Former Member · Accepted solution]

Can you explain me with a small example.

Thanks

Sonali

[Former Member · Accepted solution]

Any help on this???

[Lakshmipathi · Accepted solution]

Dear sonali

As requested, below is an example for hedge.

A stock trader believes that the stock price of Company A will rise over the next month, due to this company's new and efficient method of producing widgets. He wants to buy Company A shares to profit from their expected price increase. But Company A is part of the highly volatile widget industry. If the trader simply bought the shares based on his belief that the Company A shares were underpriced, the trade would be a speculation.

Since the trader is interested in the company, rather than the industry, he wants to hedge out the industry risk by short selling an equal value (number of shares × price) of the shares of Company A's direct competitor, Company B. If the trader were able to short sell an asset whose price had a mathematically defined relation with Company A's stock price (for example a call option on Company A shares) the trade might be essentially riskless and be called an arbitrage. But since some risk remains in the trade, it is said to be "hedged."

The first day the trader's portfolio is:

Long 1000 shares of Company A at $1 each

Short 500 shares of Company B at $2 each

(Notice that the trader has sold short the same value of shares.)

On the second day, a favorable news story about the widgets industry is published and the value of all widgets stock goes up. Company A, however, because it is a stronger company, goes up by 10%, while Company B goes up by just 5%:

Long 1000 shares of Company A at $1.10 each — $100 profit

Short 500 shares of Company B at $2.10 each — $50 loss

(In a short position, the investor loses money when the price goes up.)

The trader might regret the hedge on day two, since it reduced the profits on the Company A position. But on the third day, an unfavorable news story is published about the health effects of widgets, and all widgets stocks crash -- 50% is wiped off the value of the widgets industry in the course of a few hours. Nevertheless, since Company A is the better company, it suffers less than Company B:

Value of long position (Company A):

Day 1 — $1000

Day 2 — $1100

Day 3 — $550 => $450 loss

Value of short position (Company B):

Day 1 — $1000

Day 2 — $1050

Day 3 — $525

Without the hedge, the trader would have lost $450. But the hedge - the short sale of Company B - gives a profit of $475, for a net profit of $25 during a dramatic market collapse.

Thanks

G. Lakshmipathi

[Former Member · Accepted solution]

Hello LakshmiPathy

First of all I would like to thank you for responding to Question.

I have understood the situation on Day1 , Day2 & Day3. But I just wondered how the trader has made a profit of 25$ in his investment. What exactly is that Hedging?

Please put it simpler to clarify it.

Tons of Thanks

Sonali

[Former Member]

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