Hedging - insurance of risks against the change of prices for the worse for any goods and material assets under contracts, commercial operations, according to which the supply (sale) of goods should be carried out in subsequent periods.
There are two transactions: raising hedges and lowering hedges.
A raise hedge is an exchange transaction for the purchase of fixed-term contracts or options.
A hedge for an increase allows you to protect the company if in the future an increase in prices (rates) is expected.
With it, you can set the purchase value much earlier than the real product was purchased.
Financial risk hedging for downgrade is an exchange transaction with the sale of a fixed-term contract.
In this case, the hedger is going to sell the goods, so he insures himself against a possible price reduction by selling a fixed-term contract or option on the exchange.
The goal of consumers, manufacturers of products is to optimize price, currency risk, borrowers, lenders seek to insure against changes in interest rates, players in the stock market fear a sharp drop in quotes.
Currency risk hedging is a prerequisite for:
- exporters selling foreign exchange revenues in order to cover expenses in rubles;
- importers constantly converting revenues in rubles to ensure further deliveries;
- enterprises or investors with a large share of credit funds in currency.
If you want to understand if your company needs a hedge, you need to make a valid valuation:
- volume, share of high risk transactions in your area or investment portfolio.
When this figure is more than 50%, hedging cannot be done, no matter what the level of risk is.
- opportunities, quantitative consequences of risks - hedging is carried out for all financially dangerous situations.
Before resorting to hedging, you need to compare insured risks with financial and temporary hedge expenses.
If a company may have small losses, hedge will cost unjustifiably.
Hedging is a prerequisite for the safety of an investor in whose portfolio there are assets with an increased risk share.
Let's call the main advantages of hedging application:
- price risks are reduced;
- reduced operational risks associated with the business cycle (delivery schedules, shipments, etc.);
- there is no uncertainty factor, information transparency, the ability to predict the situation;
- increasing stability, financial stability;
- management decisions are made with greater flexibility due to the increased range of counterparties, instruments, transaction characteristics;
- the price of attracting capital and debt financing is reduced.
The hedge insurance mechanism has its disadvantages:
- inability to obtain probable additional profit of spot market;
- opening costs, fulfillment of obligations under transactions;
- basic risk of hedging, in other words, different price changes in urgent and spot markets;
- the risk of legislative changes in economic and tax policies (barrage duties, levies, excise taxes), in this case hedge will not protect the company from financial risks, on the contrary, will cause losses;
- exchange-traded restrictions, such as the daily limit of the upper and lower limit of the futures price, can cause serious losses if you have to close a fixed-term contract at the time of sharp take-off/fall of the spot market;
- growth of number, structure of transactions.
Therefore, if you want to use derivative hedging instruments, start by:
- assess the probability, scope of risks;
- match information to hedge costs;
- explore the market and mechanism of your underlying asset's specific derivative;
- create a financial risk hedging strategy;
- choose a marketplace that offers the best conditions for you;
- find a clearing company and a stock broker.