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Hedging is a financial strategy used to reduce or offset the risk of adverse price movements in assets by taking an offsetting position in a related security or derivative.

What is hedging?

Hedging serves as a risk mitigation strategy in investment portfolios, aimed at offsetting potential financial risks through various strategies. These approaches aim to counteract potential losses and reduce risks, involving actions like buying put options or selling futures contracts.

Approaches to hedging

Multiple strategies exist for hedging, including buying futures contracts, utilizing options, or employing derivatives such as forwards and swaps. These techniques provide ways to lock in asset prices or protect against unfavorable price movements.

Importance of hedging

Hedging is instrumental in reducing exposure to unforeseen market downturns or adverse events, managing currency risks, and locking in profits. It can also assist in minimizing the impact of taxes and trading costs.

Examples of hedging strategies

Hedging strategies vary, encompassing actions like purchasing put options to safeguard portfolios from market downturns or buying call options to protect against upward market movements.

Risks involved in hedging

Despite its benefits, hedging can lead to potential losses, especially if the hedged position doesn't align with the underlying one, or if the costs of hedging exceed potential losses. There's also the risk that hedging might not prevent losses and could result in even larger financial setbacks.

Approaches for risk hedging

Various methods exist to hedge against financial risks, including obtaining insurance to protect against potential losses and investing in less risky assets like government bonds or gold. Additionally, investors can employ specific strategies such as put options to safeguard against potential losses.