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Methods of Hedging
Let’s learn more about methods of Hedging. In this type of transaction, the hedger tries to fix the price at a certain level with the objective of ensuring certainty in the cost of production or revenue of sale.
The futures market also has substantial participation by speculators who take positions based on the price movement and bet upon it. Also, there are arbitrageurs who use this market to pocket profits whenever there are inefficiencies in the prices. However, they ensure that the prices of spot and futures remain correlated.
There are two kinds of hedges: Short hedge and long hedge. A short hedge is where a person that wants to sell a commodity at a particular time in the future can hedge by taking short futures position. A long hedge is when a person knows that he/she is due to buy an asset in the future can hedge by taking long futures position.
Hedging strategies are broadly classified as follows:
- Forward Contract: It is a contract between two parties for buying or selling assets on a specified date, at a particular price. This covers contracts such as forwarding exchange contracts for commodities and currencies.
- Futures Contract: This is a standard contract between two parties for buying or selling assets at an agreed price and quantity on a specified date. This covers various contracts such as a currency futures contract.
- Money Markets: These are the markets where short-term buying, selling, lending, and borrowing happen with maturities of less than a year. This includes various contracts such as covered calls on equities, money market operations for interest, and currencies.
