lnc16 - Notes 16-Hedging Hedge From Wikipedia, the free...

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Notes 16--Hedging Hedge From Wikipedia, the free encyclopedia A classic hedge involves taking opposite but equal positions in a financial market. A hedge is an investment that is taken out specifically to reduce or cancel out the risk in another investment. Hedging is a strategy designed to minimize exposure to an unwanted business risk, while still allowing the business to profit from an investment activity. Typically, a hedger might invest in a security that he believes is under-priced relative to its "fair value" (for example a mortgage loan that he is then making), and combine this with a short sale of a related security or securities. Thus the hedger doesn't care whether the market as a whole goes up or down in value, only whether the under-priced security appreciates relative to the market. Holbrook Working, a pioneer in hedging theory, called this strategy "speculation in the basis," [1] where the basis is the difference between the security's theoretical value and its actual value (or between spot and futures prices in Working's time). Some form of risk taking is inherent to any business activity. Some risks are considered to be "natural" to specific businesses, such as the risk of oil prices increasing or decreasing is natural to oil drilling and refining firms. Other forms of risk are not wanted, but cannot be avoided without hedging. Someone who has a shop, for example, can take care of natural risks such as the risk of competition, of poor or
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This note was uploaded on 11/23/2011 for the course ECON 231 taught by Professor Staff during the Fall '09 term at Calhoun Community College.

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lnc16 - Notes 16-Hedging Hedge From Wikipedia, the free...

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