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Hedging results. Hedging price risks

is the central banking institution of a given state.

History of the formation and development of the Bank of Canada

The above banking institution was founded back in March 1935. Until this time, the Canadian financial system worked on the British model. According to the latter, there was a tendency in the country to reduce banking institutions. In addition, large credit organizations were free to manage government accounts and issue.

The situation changed after the economic crisis in 1929. It became quite difficult for a country to produce when government accounts were simultaneously managed by several banking institutions. The idea of forming a Central Bank became the first necessity for Canada.

In 1933, Prime Minister Richard Bedforth Bennett appointed a royal commission that would examine Canada's financial system in every detail. This was the first step in the formation of the country's Central Bank.

It should be noted that already in 1938 the Bank of Canada was introduced as government agency, which dealt with the implementation financial policy in the country (issued money, supervised the work of other credit institutions). Soon, the tax bureau, the public debt service, the securities and currency operations service, and the department of economic research and financial development of Canada became the agencies of this bank.

Structure and organization of the Bank of Canada

The activities of the above banking institution are regulated by the special Bank of Canada Act. Its headquarters are located in the capital of the state, Ottawa. According to the law, the Central Bank has the right to establish branches at its discretion not only on the territory of the state, but also outside it (after the approval of the Governor-General of the Council).

The Bank of Canada is governed by the Authority. The latter consists of the manager, his first deputy, and four deputies. The first two persons, together with the Deputy Minister of Finance and 12 other members of the board, form the board of the above-mentioned banking institution. The manager and his first deputy are selected for their respective positions for a period of seven years from among figures with a recognized excellent financial reputation.

The Bank of Canada consists of 10 departments:

Control scientific research, which deals mainly with the analysis of the state economy.
Department financial markets, which undertakes the implementation of monetary policy, monitoring the financial markets of the country.
The Office of Monetary and Financial Research, whose prerogatives are to monitor the financial sector of the state and compile relevant reports.
Department of International Relations, which is responsible for point analysis modern development economies abroad.
Debt Management Bureau, which is responsible for providing administrative services and providing guidance on the government's debt management.
Management of services to senior management and legal services, the main task which consists of providing decision-making support to the Board of the Bank of Canada.
Banking Operations Department, which deals with customer service and issues Money.
Control Department - conducts independent assessment operations carried out by the Central Bank.
The General Services Department handles issues that tie into everything else, from purchasing equipment to managing employees.
Public Relations Department, which assists the bank in pursuing a policy of openness and transparency.

Main goals of the Bank of Canada

The activities of the above banking institution are aimed mainly at implementing the following extremely important tasks in its financial policy:

maintain the reliability of funds;
manage the state's funds and its debt;
prevent fluctuations in the country’s financial system and maintain its stability;
manage gold and foreign exchange reserves;
exercise control over the refinancing rate;
issue savings certificates of the country;
maintain a consistently low level;
issue and accordingly distribute Canadian banknotes;
use monetary policy to maintain market confidence in the value of Canada's currency;
accept responsibility for unclaimed accounts that belong to owners about whom there has been no information for at least the last 10 years.

The bank's current manager is Stephen Poloz.

Interaction with subjects

It should be noted that although the Bank of Canada is under the jurisdiction of the country's Ministry of Finance, it still has a certain independence in relation to the government.

The above-mentioned banking institution is today a bank for commercial credit institutions. In this direction he carries out the following activities:

provides loans to members of the Canadian Payments Association;
checks the amount of liquid funds in banking institutions (whether they are sufficient to make payments);
provides loans to the government;
is a consultant to the Canadian federal government.

It should be noted that the above banking institution has the right to freely open accounts in other countries, as well as in the International currency board, V International Bank reconstruction and development. In addition, the Bank of Canada can lease, acquire real estate, and dispose of it at its discretion.

The above-mentioned banking institution can maintain relations with the governments of other countries and freely buy or sell foreign currency.

Canadian currency today

The Bank of Canada adheres to the following basic principles in its monetary policy:

Change the target refinancing rate daily (the bank recommends the average interest rate to large financial institutions of the state, according to which they must provide funds to each other within one business day). Experts note that if the interest rate decreases, this entails a decrease in savings and an increase in expenses. Higher interest rates contribute to a decrease in exports and an increase in imports.
Ensuring that inflation remains at a consistently low level of inflation (experts note that the Bank of Canada has been focusing on a target interval in this direction for several years - the inflation rate in the country is about 2%, that is, its value is constantly in the range from 1 to 3% ).

Other functional responsibilities of the Bank of Canada

The above-mentioned banking institution is actively pursuing unclaimed account balances that have not had any financial transactions for the past ten years. The latter are published in a special edition.

The Bank of Canada also manages government bonds, which are issued annually by the country's government. Canadians lend their money to the government to help manage the financing of the government's debt. This policy is very beneficial for Canada. After all, borrowing money from your citizens is much better than in other countries.

The Bank of Canada is sensitizing banknotes to detect counterfeit banknotes. He actively cooperates with police at all levels and with other central banking institutions to ensure maximum security for the new money. In addition, Bank of Canada employees inform the public about situations involving counterfeit bank notes.

The above-mentioned banking institution offers services for the repayment of funds that are damaged. If a Canadian damages his bank notes to the point of being unusable appearance, then their value is necessarily established in a special laboratory of the Bank, and then the money is paid to the owner.

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Each of us regularly hedges our risks without even thinking about it. Booking tickets, hotels, reserving a table in a restaurant... All this is insurance against adverse events in the future (lack of empty seats). So why not take care of protecting your money in advance and eliminate the possibility of a losing scenario? But first you need to carefully study this method. After all, illiterate hedging led to hundreds of companies. Why? Due to a lack of understanding of its mechanisms and tasks. This article is intended to correct the situation. In it you will find 5 hedge strategies that will protect your capital.

Hedging(English hedge - insurance, guarantee) - insurance of risks and protection against possible losses by opening purchase and sale transactions for the same product (asset) on different financial markets, so that in case of losses in one market, compensate for losses with profits on another.

Hedging – a risk-free business or a direct path to bankruptcy?

What is hedging in simple words? This is an analogue of insurance, which is used where insurance is powerless. Namely, in financial markets subject to price fluctuations. Its main advantage is protection from the unknown!

This is a conservative strategy that allows you to “predict the future.” Hedger does not know how much the market value of the product will change. But he is absolutely sure that one of his transactions will in any case be in the black, and the other – in the minus. Losses will be equal to . We'll talk further about why this is necessary.

The essence of hedging is how to lock in profits and not worry about rising prices

The point of hedging is the predictability of profits. And its essence is the simultaneous conclusion of purchase and sale transactions for the same product or asset in different markets. Or for two goods, the cost of which depends on each other (for example, flour and grain, oil and gasoline).

One of them is purchased or sold in real life, on the spot market. That is, where payment is made in cash according to the “here and now” principle. And on the other hand, they buy derivatives (options, futures, forward contracts). These are legally certified purchase and sale agreements with a delay in time. Securities that are analogues of bets, in which the subject of the dispute is the cost of basic goods, currencies, shares.

They are traded on the derivatives market, where the execution of the transaction and settlements on it are postponed to the future. But when this “future” approaches, the contract is resold or bought back to avoid real deliveries. It is important! After all, the seller, as a rule, does not have the real goods. He just wants to “play” on the price difference.

Important point! Prices for the same asset in the spot and derivatives markets differ. For example, the price of 1 barrel of oil on the spot market is $55, and on the futures market – $57.5. When purchasing 200,000 barrels, the difference is (57.5 – 55)*200,000 = $500,000. That is half a million dollars! This value is included in the concept of basis risk.

But let's return to the hedging mechanism. Thus, the profit is locked in: when one trade is in the red, the other is automatically in the black. This ensures compensation for losses. In its classic form, hedging allows you to break even. That is, it is a method of reducing the risk of losing money by refusing to increase profits. Wherever the price moves, it will bring neither losses nor gains. Who benefits from this?

Companies whose main income does not come from exchange trading, but depends on the assets presented on it. For example:

Banks and importing companies, as well as exporters paying in currencies with a constantly changing exchange rate. Let's take for example a bank that receives income in US dollars and pays interest to depositors in rubles. If the dollar rate rises, the bank receives more in terms of RUB and is a winner. After all, he gives investors, for example, 100,000, and receives 110,000 rubles. But if the USD falls, this company suffers losses (it gives 100,000 and receives 90,000 rubles). The bank does not want to depend on chance and is satisfied with the current quote value. Therefore, he “stakes out” the right to exchange dollars for rubles from another bank in a month, but at today’s price. This is called a forward contract. Neither party has the right to terminate it. Now the bank doesn’t care what happens to the price of USD! He will receive exactly as much in rubles as he planned.
Producers and large consumers of fuel (airlines, carriers). Let's give an example. A cargo transportation company purchases in a month diesel fuel. To insure herself against rising prices, she “argues” with the manufacturer that the cost of fuel will increase. That is, he makes a “bet” on a position that is unfavorable for himself! The dispute is fixed by the purchase of fuel futures. If after a month diesel becomes cheaper, the company wins on its purchase, but loses the “argument.” And if it goes up in price, he suffers losses, but covers them with winnings from this “bet”. The main thing is that the cargo carrier knows that he will not remain in the red under any circumstances!
Confectionery shops requiring large volumes of flour and sugar. For example, once a quarter a company producing sweets purchases 10 tons of sugar. In order not to depend on price fluctuations, she “argues” with another company that sugar will rise in price. If this turns out to be the case, the confectionery shop wins the “argument” and with this money covers the losses from purchases. And, if sugar becomes cheaper, the company receives more revenue, part of which it gives for a bet.
Companies involved in gold and oil mining. For example, the company GoldenStar is engaged in gold mining. It invests huge amounts of money in excavations and storage of these raw materials. Therefore, he wants to be sure that the proceeds from metal sales will not only cover expenses, but also bring profit. GoldenStar pays $2,000 to the financial exchange for the right to sell its goods in the winter at a summer price. This is called an option. What will happen next? Let's say the price of gold falls in winter. Competitors suffer losses, but GoldenStar counts profits. After all, the company has the right to sell the metal at a higher price - the same as it cost in the summer! But what if prices rise? In this case, the company simply waives the right to sell its goods at the now low prices. And $2,000 remains on the exchange as a risk payment. This is analogous to an insurance premium.
For farmers.They either make a bet that their product will become cheaper. And then the benefits from the dispute cover the losses from sales. Or they sign a contract without the right to terminate. According to it, after the harvest, the farmer delivers grain or large cattle to the buyer at the price agreed upon today. And it doesn’t matter whether the current value of the product has increased or fallen.

Business example - how to cover a loss of 200 million dollars

Let's consider a classic situation in which hedging is necessary. A company from the Russian Federation (let's call it Sibbur) supplies oil to the United States. The settlement currency is American dollars. In February, a contract is concluded for the supply of 200,000 barrels (1 barrel = 0.1364 tons) at a price of $55 per barrel. The total transaction amount is $11,000,000, delivery date is May 2015.

On February 3, 2015, the dollar exchange rate was 69.66 rubles/$1. That is, the Russian company Sibbur expects to receive 200,000 * 55 * 69.66 = 766,260,000 rubles. And on May 16, the dollar falls to 50.07 rubles/$1 and for the same volume of oil the exporting company receives 200,000 * 55 * 50.07 = 550,770,000 rubles. Losses equal to 215.5 million rubles! It is not easy to predict such an outcome, since the ratio of currencies is constantly changing.

There are two exit options:

Terminate the contract and sell oil at a higher spot price ($66.78 per barrel). Then total income will be 668,734,920 rubles (200,000 * 66.78 * 50.07 = 668,734,920). Thus, losses will be reduced to 97.5 million rubles.
Hedge the deal in advance by concluding a futures contract to sell $10,000,000. That is, a legally certified agreement that binds two parties with a chain of obligations. On the one hand, to deliver the currency at a specified future date, and on the other hand, to pay a fixed amount for it in another currency. Why not 11 million? It all depends on the hedge ratio (more on this in the next section). It is related to the size of the correlation between prices in the spot and derivatives markets. That is, by how synchronously they change.
Let's calculate the outcome of the transaction: $1 on the derivatives market in February 2015 costs 66.78 rubles (the spot price, as we remember, is 69.66 rubles). We multiply 10,000,000 by 66.78 and get 667,800,000 rubles - these are the costs of the transaction. In May, $1 = 48.7 rubles, and 10 million dollars are already worth 487,000,000 rubles. The Sibbur company sold dollar futures at a higher price, and is now buying it back at a lower price. The drop in value brings the company $180.8 million.

To summarize, based on the results of oil sales, Sibbur loses 215.5 million rubles. And as a result of a futures transaction for dollars, he receives 180.8 million rubles. The overall balance is negative: 180.8 – 215.5 = -34.7 million rubles. But the loss was reduced from 215.5 million.

Or you can combine two options: hedge the deal in dollars and break the supply contract at an unfavorable price. And then the company not only will not lose anything, but will also win 83.3 million rubles! From this amount you will need to subtract the futures premium and the forward penalty. But the balance will still remain positive.

Why then do Russian companies have a negative attitude towards hedging? Because for most of them it brings multi-billion dollar losses. We will talk further about the advantages and disadvantages of this method, as well as when it is not necessary to use it.

What is a hedge ratio and why is it needed?

Main question, which faces a company that decides to hedge its risks, how many futures or other contracts it will need for this. This is where the need for a hedge ratio comes into play. This is a number from 0 to 1 (most often 0.7 - 0.9), by which the insured amount must be multiplied (11 million from the previous example). The closer this number is to one, the more complete the hedge. That is, the more fully the company will cover its losses in the event of a negative outcome of the situation.

Why make it so complicated? The fact is that prices for real goods and contracts for them (options, futures, etc.) fluctuate differently. For example, oil on the spot market is growing by 1.13%, and the cost of oil futures on the derivatives market is increasing only by 0.58% (as in October 2017).

The hedge ratio is calculated using different formulas. The simplest one:

Where ρ (rho) is the correlation between spot and futures prices; δS (delta) – parameter of price changes on the spot market; δF – parameter of price changes on the futures (forward) market.

To determine δF and δS, a period of time equal to the period of future hedging is taken. For example, in October we plan to open a 3-month deal (until January). To calculate the hedge ratio, you should take data for the previous 3 months (September, August and July). It is believed that history always repeats itself and its future is hidden in the price’s past!

The delta can be determined using a complex formula with the sum of squares and subtraction of the root. To do this, you need to calculate the square of each of the three prices (for September, August and July). Add the sum of these squares and divide them by the number of months (in our case 3).

If δS turns out to be equal to δF, then the hedge ratio will be 1. This is an ideal hedge that never occurs in life! After all, it requires extreme synchronicity between the two markets.

Pros and cons of the method

Hedging has obvious and non-obvious advantages. This:

protection against unfavorable price movements;
loyalty of banks in relation to issuing loans (if risks are controlled, the company can receive money for better conditions);
possibility of precise planning (the amount of profit and loss is known in advance).

But the method also has significant drawbacks. These include:

High prices for futures, options and other hedging instruments. Hedging is a transfer of risk to another market participant (exchange, bank, fund, private company). But you have to pay for the risk! For example, the collateral value of 1 oil futures (the amount that needs to be deposited into the account, even if you do not intend to complete delivery) is $6.25 thousand. And the option premium paid to the exchange when purchasing it is $2 thousand.
Difference in terms of execution. It may take 1-2 months between the delivery of the actual product and the closing of the transaction on the exchange.
Significant differences in prices on the spot and derivatives markets due to different grades of goods. As a result, the profit on one trade may not be enough to cover the loss on another. For example, a company buys kerosene at a price of 45,753 rubles/t, and there are futures only for fuel oil, the cost of which is 27,932 rubles/t. The difference is big, and prices can change very asynchronously.
Complexity of calculations. The number of contracts that need to be purchased on the derivatives market depends on the correlation of prices, the difference between them, the delta of changes, etc.

An exception to the rule – when it’s better to forget about hedging

Hedging – Lifebuoy for companies that deal with deferred payments. But the decision to use it should be based primarily on an analysis of the work of competitors.

If hedging is not used in the area where the company operates, there is no point in experimenting. Because the result will either be very good or catastrophically bad (without a middle ground). As a result, you will have to increase your prices, which will lead to the loss of customers.

Let's take an airline as an example (let's call it NewAirlines). She constantly needs fuel (kerosene), which often changes in price. Therefore, simultaneously with its purchase, the company enters into a futures contract for the sale of fuel oil (remember that kerosene is not traded on the futures exchange).

At its core, the contract is fictitious. After all, the airline doesn’t have any fuel oil! And when the futures expiration approaches, she will buy it back. But at a different price. The price difference could result in a profit or loss for NewAirlines.

Let's assume that other airlines do not hedge their risks. What will happen in this case?

Option #1: fuel prices will rise. NewAirlines will incur losses on the purchase of kerosene, but will gain on the sale of fuel oil. Its competitors will simply raise ticket prices and compensate for their losses. In this case, our airline will also follow their example, and its income will increase significantly.

Option No. 2: fuel prices will decrease. NewAirlines will win on the kerosene purchase, but will give up that profit on a futures deal that went into the red. The company's competitors will lower ticket prices due to excess profits. And NewAirlines will leave them at the same level, which will lead to the loss of customers. Because if you reduce it together with your competitors, you will lose your profit and work at a loss.

Types of Hedging – When Size Matters

Hedging can be divided according to several parameters:

by instrument used – exchange and over-the-counter;
in the direction of the transaction (buy or sell) – long and short.

Where to conclude contracts - on the exchange or outside it?

Exchange types of hedging include futures and options. And over-the-counter ones include forward contracts and swaps (exotic options can also be traded over-the-counter).

All of them are derivatives. These are contracts that trade not a commodity, currency or shares, but rights and obligations in relation to them. For example, you can buy the right to receive oil at a favorable price in the future. Or sell an obligation to supply gold over time at a price that suits your buyer.

The following table illustrates the main differences between derivatives.

Table 1. Differences between derivatives

Derivative	Standardization	Exchange participation	Calculation	Liabilities	Price
Forward	Can have any volume, grade, quality of goods, delivery/calculation date	Traded outside the exchange, directly between participants	Once upon expiration of the transaction	Mandatory (actual delivery or financial compensation)	Advance payment is not required, can be up to 20% of the asset value
Futures	All parameters, lead time and quantity of goods are strictly standardized	You can buy/sell only on the exchange	Recalculated daily	Binding, but can be resold	The collateral value is paid from 2 to 15% of the asset price
Option	Standardized on the exchange, but not standardized outside it	Can be exchange-traded or over-the-counter	Any day before or after the option expires (depending on the type of contract)	Not binding, can be terminated unilaterally	A fixed premium is paid on the option
Swap	Not standardized	The contract is concluded outside the exchange, directly	Regularly (quarterly, monthly, or on other agreed terms)	Mandatory	A percentage of the exchange transaction is paid

Let's look at each of the derivatives using the example of the same company Sibbur from the Russian Federation, which supplies oil to the United States. We described the hedging mechanism in this case above.

So, the company’s goal is to hedge risks associated with fluctuations in the dollar-ruble exchange rate. How does this happen:

Forward contract. The Sibbur company enters into an agreement with another company to supply rubles for dollars. According to him, on May 16, Sibbur gives her $10 million, and in return receives 667.8 million rubles. Advance is not provided. At the time of expiration of the transaction, a representative of Sibbur brings containers with dollars and takes away containers with rubles. This is the only contract where there are real deliveries!
Futures. To insure his $10 million, Sibbur sells 10,000 futures contracts for the supply of USD on the Moscow Exchange. Why 10 thousand? Because each contract = $1,000 (1,000 * 10,000 = 10,000,000). The total cost of the transaction is 667.8 million rubles. The company transfers $200,000 to the account at the exchange - this is the collateral value to secure operations. Every day, the cost of contracts is recalculated at the current rate and the amount in the account changes. The deal expires on May 16, and if it is not bought back, the company will be obliged to supply dollars, as in the example above. On May 12, Sibbur decides to buy out his contracts for 511 million rubles. The difference is 156.8 million rubles. the company takes it as a profit (minus 6% for exchange services, the result is 147.4 million rubles). In an unfavorable situation (the dollar exchange rate is rising), the company also buys back the futures, but at a higher price, losing money.
Option. Sibbur buys a Put option with the right to sell the dollar in May at 65 rubles/$1, expecting that the currency will become cheaper. And pays a premium to the exchange in the amount of 27.26 million rubles. This is the amount of overpayment - the price at which the exchange estimates its own risk. For comparison, the overpayment for futures will be 9.4 million rubles. This is the so-called “contango” - a premium for deferred payment. But let's return to option execution. May comes, the dollar exchange rate drops to 51 rubles/$1. And Sibbur exercises his option, supplying 10 million American currency in exchange for 650 million rubles. Profit is equal to: 650,000,000 rubles. – 510,000,000 rub. – 27,260,000 rub. (option premium) = 112,740,000 rubles. This is 34,660,000 rubles less than in the previous example, but the losses are compensated by the flexibility of the option. For example, it can be executed on any day before the expiration date (when the dollar reaches its lowest possible level). Whereas futures, only at an agreed time. But, if the price of USD rises (for example, to 68 rubles/$1), it becomes unprofitable for the company to exercise the option. Since her losses will be: 650,000,000 rubles. – 680,000,000 rub. – 27,260,000 rub. (premium) = 57,260,000 rub. In this case, Sibbur simply breaks the contract, and the profit from the sale of the rising currency covers the loss from the paid option premium. The company receives 30 million rubles more than it should have under the option, but almost everything is “eaten up” by the overpayment (27.26 million rubles).
Swap. Sibbur enters into a contract with the bank, changing the floating dollar exchange rate to a fixed one. This allows you to achieve stability and not depend on fluctuations in the USD exchange rate. On February 15, the company receives 600 million rubles from the bank, which is enough for it to successfully conduct business. And on May 15 he transfers $10 million to the bank. The benefit from the floating exchange rate makes the deal interesting for the bank. After all, as a rule, there is a third party. The bank sells her dollars at a slightly higher price due to changes in the exchange rate.

Short or long – which hedge is better to choose?

Now let's move on to the issue of the “length” of the hedge. It depends on what outcome the market participant is trying to avoid. A short position is the sale of a futures contract at high price, so that in case of a downgrade, you can buy back the contract with a profit. The principle is simple - you sell it at a higher price, buy it back cheaper, and put the difference in your pocket. Such a transaction is opened if the hedger is a supplier of products to the commodity market. That is, he needs protection from falling prices.

Conversely, a long hedge is the purchase of a futures contract with the goal of selling it at a higher price when prices rise. Here everything is the same as in the first case: buy cheaper - sell more expensive. Only the order of actions changes (first buying, then selling). This is the behavior of consumers who need protection from price increases. Let's look at an example.

A wheat farmer does not want to incur losses from falling prices for his product. Therefore, it carries out a short hedge on the derivatives market - it sells futures for its products. And the flour manufacturer purchasing grain wants to insure itself against rising prices. He opens a long position - buys wheat futures.

Neither one nor the other is going to bring the contracts to completion. They just need to play the price difference to their advantage! Now it's all in numbers.

September wheat futures are trading at $4.3 per bushel. This is the American Mercantile Exchange measure of weight, which is equal to 27.2 kg (or 3 buckets). 1 futures holds 5,000 bushels (136,000 kg or 136 tons). The farmer sells 1 futures, and the flour manufacturer buys it. The contract price in both cases: $4.3*5,000 = $21,500. Now let’s look at the options for moving the price of grain:

The price is going up - wheat rises to $5.7/bushel. The contract is no longer worth $21,500, but $28,500 ($5.7*5,000 = $28,500). The difference is $7,000. Only for the farmer this is a loss, because he buys back the short futures. And for the flour manufacturer - profit, because he sells a long position. As a result, both break even: the farmer sells the real product for $7,000 more, and the flour manufacturer buys it for $7,000 more. Both profits and losses are compensated by transactions on the real market.
The price is going down - grain is falling in price to $4.1/bushel. The contract becomes equal to: $4.1*5,000 = $20,500 ($1,000 less). The farmer buys a short futures contract, making a profit of $1,000. And the manufacturing company sells a long contract with a minus of $1,000. The situation, as in the previous case, is equalized in the real market.

The Hot Five – Hedging Strategies for Any Situation

The following types of hedging strategies are distinguished:

by asset selection: direct (for example, oil-oil), cross (gasoline-oil) and composite (gasoline-oil-fuel oil-US dollar);
for making changes: static (bought and forgotten) and dynamic (positions are adjusted every day).

Strategies can be combined. Let's look at each in more detail.

Strategy #1: Direct Hedging

A gold mining company (say GoldRush) sells gold futures. So, if prices fall, it will cover the loss from metal sales with profit on the exchange. After all, the company will buy out its contract at a lower price!

Strategy #2: Cross Hedging

GoldRush buys dollar futures. Because he knows that when gold prices fall, the USD rate rises. This option covers no more than 70% of the risks, but makes it possible to extract more profit.

Strategy #3: Compound Hedging

GoldRush buys dollar futures and sells gold futures. In this way, it further spreads the risks. After all, it may happen that gold will fall in price by 10%, and the dollar will rise by only 3% and will not cover the losses on the precious metal (with cross-hedging). Or both assets will simultaneously rise/fall in price, destroying the very essence of the insurance transaction. In these cases, profit or loss will be accrued separately, without dependence on each other. This means that the firm will have a greater chance of reaping financial benefits from operations.

Strategy #4: Static Hedge

GoldRush buys 100 futures in March and sells them in October. Everything that happens to the price in this period of time does not interest her. The transaction is not revised or adjusted.

Strategy #5: Dynamic Hedging

The company buys 100 US dollar futures in March and simultaneously sells 100 gold futures. Analyzing the market, in April she buys another 15 USD futures. And in May he sells 25 contracts for gold. This is how GoldRush extracts maximum profit on all assets because it monitors price movements and reacts to them in a timely manner. Every fluctuation in the dollar exchange rate and the cost of grain is covered by hedging and even brings profit!

The last strategy is the most popular. It is also called delta hedging because it takes into account the delta of price changes to analyze the market.

Conclusion

Hedging is a delicate tool that should only be used after careful calculations. He “conserves” profit, preventing it from growing or falling. Therefore, when concluding an insurance deal, be prepared to give up a pleasant bonus in the form of a budget surplus! In return, you will receive something more - confidence in financial stability in the future and independence from price fluctuations.

The essence of the method is the combination of work in two markets - real and “virtual”, where transactions in 90% of cases are not completed. Since the seller does not have the real product, and the buyer does not need it. Their common goal– play on the movement of exchange rates or the value of an asset by placing a bet.

This market for “ghost” contracts (derivatives) is called a forward market, since the principle of its operation is to receive deferred payments. A simplified example: it sells non-existent chairs when the tree for them still grows in the forest.

There are several options for insurance transactions: futures, forwards, swaps and options. Each of them has its own characteristics in terms of execution time, the ability to refuse the operation, and the amount of overpayment. This allows us to adapt to the specific needs of all market participants. So banks most often use swaps, farmers use futures, and large producers use forwards.

To cover the risks to the maximum, the hedge ratio is calculated. It shows how many “virtual” transactions must be concluded in order to insure a real one. After all, prices in the two markets change differently! The complexity of calculations and a large fee for risk in the form of a premium to the exchange or collateral for a transaction are the main disadvantages of hedging. They must be taken into account when deciding on the advisability of a hedge!

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Dispatch

The Forex market is characterized by the fact that it is characterized by significant fluctuations in exchange rates. To protect assets from negative changes in exchange rates, a financial instrument such as hedging is provided.

Description

Since prices tend to change over time, buyers and sellers seek to protect themselves from possible losses associated with this. They create effective mechanisms to minimize Negative consequences that are possible as a result of price changes.

Any company, whether associated with financial activities, or with agricultural activities has monetary risks. These risks may be hidden in such aspects as the sale of products, depreciation of assets in which part of the capital is invested, etc. Risks imply that as a result of its operations the company will receive a loss, or not such a large profit as it expected due to the fact that the price of the asset at the time of the operation has changed. Of course, in addition to the possibility of incurring losses due to price changes, there is the possibility of making a profit from a more profitable transaction with the asset. But despite this fact, most successful companies have always sought to reduce risks first, even if this meant giving up the possibility of making large profits. Therefore, such derivative financial instruments as options, futures, and forward contracts were born. Companies or individuals who reduce their risks using these instruments, in other words, hedge their assets, and the specific individuals who do this are called hedgers.

Hedging(English hedge - to fence off, to limit, to avoid a direct answer) - the creation of investments in order to reduce the risk of unfavorable changes in prices for a particular asset. Typically, hedging involves opening an opposing position on the same asset, for example, in the form of its futures contract.

Investors use this strategy when they are unsure of where the market will move. An ideal hedge eliminates risks (except for the cost of hedging).

If the size of the hedging position is greater than that which needs to be hedged, it is called over-hedging.

If a company or investor decides to cancel its hedging positions, this is called de-hedge.

Hedging and the concept of risk

The very concept of hedging cannot be deeply disclosed without defining the concept of risk.

Risk is the probability of an unfavorable outcome of a transaction, which may result in loss of monetary assets, loss of income, or additional expenses. In the foreign exchange market, this outcome may be affected, for example, by changes in interest rates or exchange rates.

All financial assets are subject to certain risks. For the convenience of dividing risk into groups, there is a generally accepted classification of risks. It states that risks are divided into interest and price, as well as credit (risks of failure to fulfill obligations under the contract).

To insure an asset against the occurrence of certain risks, transactions under common name hedging. Thanks to hedging, even if they come unfavourable conditions, losses will be reduced to zero.

Risk hedging is aimed at reducing risks to zero, but thereby it also reduces the likelihood of obtaining greater profits, because risk and profit are always directly related.

The purpose of hedging is not always to minimize risks; sometimes hedging is carried out to optimize risks. For example, for this purpose, some invest their funds in hedge funds.

Hedging as a tool for a forex trader

A trader with open positions can hedge against negative price movements to prevent a loss from increasing or to preserve a profit. To do this, he does not have to close the deal. He can hedge his position, i.e. take measures to protect your position from possible unwanted price changes. A hedging operation involves not only eliminating risk, but also giving up profits that could be received if the price changes in a favorable direction.

In order to hedge, a trader only needs to open an opposite position for the same currency pair in the same volume. In other words, the trader needs to lock the position. Locking a position has another name that reflects the essence of the method - lock. The lock locks the position and eliminates risks associated with unfavorable price movements. Wherever the price now goes, the profit on one position will cover the losses on the other.

It turns out that hedging an open position in the Forex market is an investment aimed at avoiding the risk associated with a possible negative change in prices.

Hedging does not necessarily imply one counter position, there may be several of them. The main thing is that the volumes of opposite orders are equal to balance profits and losses.

It is worth noting that there is a more profitable way to hedge on Forex. The method involves reducing the risk of total losses on positions to zero, but at the same time receiving indirect profit from these positions. This is about positive swap method(arbitration interest rates between brokers).

As a result, we have two positions, mutually overlapping each other, which can bring neither loss nor profit. But thanks to the accrual of a positive swap, end result is the profit from these two operations. The main advantage of this method is making a profit and eliminating the risks associated with currency fluctuations.

An example is located in Figure 1.

Fig.1 Application of the positive swap method

As an example, it graphically displays a hedging operation using the positive swap method for the EUR/AUD currency pair. Broker A, who charges swaps, had a buy order open, and broker B, who does not charge swaps, had an opposite sell order. Broker A charges a swap of $1.64 per lot for one transfer of a long position to the next day. As a result of hedging funds, fluctuations in currency quotes do not affect the total profit and loss, which is equal to zero. Thanks to this, funds are protected from the risk of loss. But at the same time, we have the accrual of a positive swap. The accrued swap for the year is $328. So, in in this example, using the positive swap method, we created a positive cash flow at $328 per year, while protecting your funds from unfavorable price changes.

In order to maximize profits, it is important to follow several rules of the positive swap method:

The higher the difference in interest rates on a currency pair, the higher the swap will be charged, and this figure may differ for different brokers.

It is necessary to familiarize yourself in advance with such subtleties of trading with a broker, such as commissions, no restrictions on the duration of trading

Capital required to secure transactions

It is required to carry out timely position management, including the transfer of profit from a position in profit to a position in the red, in order to eliminate the possibility of a margin call on one of the positions.

Asset hedging

Constant changes in quotes on foreign exchange markets lead to the fact that foreign exchange markets are classified as a high risk group. Many different financial institutions, companies and individuals simply want to avoid the risks associated with foreign exchange transactions, or at least reduce them.

Currency hedging is the opening of forward transactions for the purchase/sale of currency in order to avoid losses associated with changes in exchange rates. Transactions are opened to fix the exchange rate that is in effect at the time of the transaction.

A large number of companies hold their assets in their native currency. If they are faced with the need to purchase another currency, for example, for the needs of a company, then it is possible to make a profit or loss compared to the previous rate. This situation is happening to many people now. Russian companies one way or another forced to work with American currency. The sharp depreciation of the ruble against the dollar led to many companies suffering losses in relation to their value in US dollars by more than double. If these companies had hedged their assets in a timely manner, they would probably have been insured against this situation, and their assets would have had the same value in foreign currency, despite the crisis in Russia.

Thus, hedging in foreign exchange markets is a tool that allows you to insure your funds against unfavorable changes in exchange rates. This happens by opening a position on a currency pair to fix the current exchange rate. This allows the company to avoid the risk of changes in the exchange rate and realistically assess the future development model of the company and its financial results in order to plan further work, product costs, profits, salaries, etc.

Currency Hedging Example

Let's consider clear example hedging currencies on the Forex market for the needs of the company. Let's assume that a company has entered into a contract with a supplier for the supply of equipment. According to the contract, the supplier must deliver this equipment in 6 months. Payment for equipment must also be made 6 months immediately after delivery of the equipment. The calculation must be made in dollars. The company's base currency is rubles.

Now the company faces the risk that the USDRUB exchange rate may change significantly in 6 months, and it will incur losses as a result of converting rubles into dollars. Of course, there is a possibility that the exchange rate will change in a favorable direction and the company will thus make a profit, but, as a rule, all competitive companies are focused primarily on reducing risks. The company also needs stability and the most accurate planning of future expenses and income.

The company, in order to avoid the risk associated with the possibility of a negative change in the exchange rate, carries out hedging. It opens a buy position for the amount of the transaction on the forex market for the USDRUB currency pair. In 6 months, when she has paid the suppliers, she will close the deal. Now, if the price increases in 6 months, the company will make a profit on this position, which will offset the losses resulting from the purchase of dollars on the day of the transaction. If the price goes down, the company will receive a loss on the Forex position, which will be offset by the profit as a result of buying dollars at a favorable rate on the day of the transaction. In other words, no matter where the price goes, the company as a whole will not make any loss or profit. The company fixed the rate in effect at the time the contract was entered into using a hedging transaction.

A visual representation of this hedging transaction is shown in the figure below.

On the other hand, if payment for equipment in 6 months were to be made in rubles, the supplier with the base currency USD should protect itself from negative changes in the exchange rate, so as not to lose profit during conversion. To do this, he should open a position on the Forex market to sell the USDRUB currency pair, and close it on the settlement day. So he would hedge the expected profit by fixing the exchange rate valid at the time of the transaction.

It is worth adding that this is not the only option for hedging currency in this situation. Alternatively, you could buy futures on the USDRUB currency pair for a period of 6 months at the price formed at the current moment. When the obligations came due, the company would execute the futures by purchasing the currency at the price formed 6 months ago.

So, hedging on Forex allows you to eliminate or minimize the risks of changes in exchange rates. Hedging is carried out to fix the value of a currency for a required period of time. The company insures itself against future losses, but at the same time refuses possible profits. The result of the hedging is zero profit and loss, excluding the costs of the hedging itself.

Benefits of Forex Hedging

Forex is a market that allows for margin trading. Thanks to it, you can open a transaction in Forex with a volume significantly larger than the collateral. This allows you to hedge currency on the Forex market to the required extent, practically without withdrawing funds from the company’s turnover until the immediate date of payment.

HEDGING

(Hedging against inflation) Protecting your capital from inflationary shocks by purchasing stocks or investing in other assets that are expected to appreciate in value as prices rise.

Finance. Dictionary. 2nd ed. - M.: "INFRA-M", Publishing House "Ves Mir". Brian Butler, Brian Johnson, Graham Sidwell and others. General edition: Doctor of Economics Osadchaya I.M.. 2000 .

HEDGING

HEDGING is a form of insurance of price and profit when making futures transactions, when the seller (buyer) simultaneously purchases (sells) the corresponding number of futures contracts. HEDGING enables entrepreneurs to insure themselves against possible losses by the time the transaction is liquidated for a period of time, provides increased flexibility and efficiency of commercial transactions, and reduces the cost of financing trade in real goods. HEDGING allows you to reduce the risk of the parties: losses from changes in commodity prices are compensated by gains on futures.

Dictionary of financial terms.

Hedging

Finam Financial Dictionary.

Hedging

Hedging - in foreign exchange markets - purchase (sale) of foreign exchange contracts for a period simultaneously with the sale (purchase) cash currency with the same delivery time and conducting a reverse operation with the arrival of the actual delivery date of the currency.

In English: Hedging

Finam Financial Dictionary.

Hedging

Hedging - in real goods markets - reducing the risk of losses caused by adverse changes market prices for goods to be sold or purchased at future prices.
When hedging, the seller (buyer) of a commodity enters into an agreement for its sale (purchase) and at the same time carries out a futures transaction opposite character. In this case, any price change brings sellers (buyers) a loss on one contract and a gain on another.

Finam Financial Dictionary.

Hedging

Hedging - in derivatives markets - the protection of open positions at risk, the price of which is expected to fluctuate during the period while the position remains at risk.

Finam Financial Dictionary.

Hedging

Hedging - in futures markets - is a form of insurance of price and profit when making futures transactions, when the seller (buyer) simultaneously purchases (sells) the corresponding number of futures contracts.

Finam Financial Dictionary.

Hedging

Hedging is insurance against the risk of price changes by taking an opposite position on a parallel market.
Hedging:
- makes it possible to insure yourself against possible losses by the time the transaction is liquidated for a period;
- provides increased flexibility and efficiency of commercial operations;
- ensures reduction of costs for financing trade in real goods;
- allows you to reduce the risks of the parties: losses from changes in commodity prices are compensated by gains on futures.

In English: Hedging

Finam Financial Dictionary.

Hedging

What's happened hedging?

The modern economy is characterized by significant price fluctuations for many types of goods. Producers and consumers are interested in creating effective mechanisms that can protect them from unexpected price changes and minimize adverse economic consequences.
There are always financial risks in the activities of any company, be it an investment fund or an agricultural producer. They can be associated with anything: the sale of manufactured products, the risk of depreciation of capital invested in any assets, the purchase of assets. This means that in the course of their activities, companies, other legal entities and individuals are faced with the likelihood that as a result of their operations they will receive a loss, or the profit will not be what they expected due to an unforeseen change in the price of that asset. with which the operation is performed. Risk involves both the possibility of loss and the possibility of gain, but people, in most cases, are risk averse, and therefore they are willing to give up more profit to reduce the risk of loss.
For this purpose, derivative financial instruments - forwards, futures, options - were created, and operations to reduce risk with the help of these derivatives were called hedging(from the English hedge, which means to enclose with a fence, to limit, to avoid a direct answer).

Hedging concept impossible to reveal without a clue risk.

The risk is– the likelihood (threat) of losing part of one’s resources, losing income or incurring additional expenses as a result of certain financial transactions.

Any asset, cash flow or financial instrument is subject to the risk of impairment. These risks, according to the generally accepted classification, are divided mainly into price and interest. Separately, we can highlight the risk of non-fulfillment of contractual obligations (since financial instruments are essentially contracts), called credit.

Thus, hedging is the use of one instrument to reduce the risk associated with the adverse impact of market factors on the price of another related instrument or on the cash flows generated by it.
Usually hedging means simply insuring the risk of changes in the price of an asset, interest rate or exchange rate using derivatives, all this is included in the concept hedging financial risks(since there are other risks, such as operational ones). Financial risk is the risk that a market agent is exposed to due to its dependence on market factors such as interest rates, exchange rates and commodity prices. Most financial risks can be hedged due to the presence of developed and efficient markets in which these risks are redistributed among participants.

Risk hedging is based on a strategy for minimizing unwanted risks, so the result of the operation may also be a decrease in potential profit, since profit, as is known, is in inverse relationship with risk.
If previously hedging was used solely to minimize price risks, now the purpose of hedging is not to eliminate risks, but to optimize them.

Hedging mechanism consists in balancing obligations in the cash market (commodities, securities, currencies) and opposite in direction in the futures market. So, in order to protect against monetary losses on a certain asset (instrument), a position can be opened on another asset (instrument), which, according to the hedger, can compensate for this type of loss.

Thus, Hedge is a specific investment made to reduce the risk of price movements, such as options or short selling;

The cost of hedging should be assessed taking into account possible losses in the event of abandonment of the hedge. In this regard, it should be noted that strategies based on derivatives financial instruments, are used instead traditional ways precisely due to lower overhead costs due to the high liquidity of derivatives markets.

Glossary of terms and abbreviations of the forex market, Forex EuroClub.

Hedging

Insurance against losses. A transaction undertaken by a trader or dealer who wishes to protect an open position at risk, primarily the sale or purchase of a commodity, currency, security, etc., the price of which is expected to fluctuate during the period that the position remains at risk. For example, a manufacturer has entered into a contract to sell a large batch of goods in six months. If its production depends on the supply of raw materials, the price of which fluctuates, and if it does not have sufficient stocks of these raw materials, it is at risk. He may decide to secure his position by purchasing the necessary raw materials through a futures contract. If raw materials must be paid for in foreign currency, the manufacturer's foreign exchange needs can be insured by purchasing the required currency under a forward contract or through an option. Such operations do not give full protection, since spot prices and futures prices do not always match, but hedging can significantly reduce the exposure of a risk position. Buying futures and options to protect against risk is just one type of hedging, which is called "long" hedging. In short hedging, something is sold to cover risks. For example, a fund manager may have a large holding of long-term fixed income investments and fears that an expected rise in interest rates will reduce the value of the portfolio of securities. This risk can be hedged by selling interest rate futures on the financial futures market. When interest rates rise, losses in the value of the securities portfolio will be offset by profits obtained by offsetting sales of futures at a lower price.

Terminological dictionary of banking and financial terms. 2011 .

Synonyms:

See what "HEDGING" is in other dictionaries:

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Books

Fundamentals of financial calculations. Asset portfolios, optimization and hedging. Textbook, Kasimov Yuri Fedorovich, Al-Nator Mohammed Subhi, Kolesnikov Alexey Nikolaevich. The third part examines stochastic methods for analyzing financial markets. Modern portfolio theory (Markovich theory) and valuation model are outlined here. financial assets(SARM).…

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