Singapore Entrepreneurs Network & Startup Organization

http://practicaleconomics.blogspot.com/2007/08/hedging.html

Some financial tricks of the trade.

"Hedging" can get quite complicated in high finance with fascinating terms like "dynamic programming" where the "programming" mentioned have nothing to do with computers. (mathematical programming)

I hope this "introduction" to shedding risk using financial instruments (a.k.a. hedging) is simple and interesting enough for the uninitiated! I wrote everything very late into the night, so please inform me if there are any gross grammatical error or incoherent passages.

A question i poised to a friend of mine the other day was:

"If you buy 100 shares of a company and its price rose by $1, you stand to make $100 in profit if you sell the shares now. But to avoid some interesting taxation, you want to keep this $100 profit unrealised. Yet you do not want to risk losing the $100 profit due to future price changes.

What can you do?"

I gave a rather silly answer which can be found in my blog post. Enjoy! (Experienced financial experts don't kill me please!)

Education is a progressive journey to discover our own ignorance - William Durant.

Anyway there isn't anyone here to fight with, unlike the last time.


I see it as one of the many tool in the financial toolbox.

The hedge itself might present an arbitrage opportunity. If asset A and asset B are perfect hedges for each other, any difference in pricing is essentially risk free profits.

Also, the reduction of risk might help to maximize profitability instead of hindering the process. For example, a hedge in an option strategy might sometimes lower the margin requirement and allow the investor to derive more returns from their capital.

But this is just one of the facets in a complete trading strategy.