Hedging

Hedging

Summary of Hedging

The act of avoiding price fluctuations over time of commodities or foreign currencies by buying or selling “forward.”By hedging, a merchant fixes the future price of a commodity or currency. For example, an American who has purchased ten thousand yards of cloth at one pound per yard from a British supplier on ninety-day terms must be prepared to settle a ten-thousand- pound obligation ninety days hence. The American merchant may buy pounds now and hold them for ninety days; if he waits until the obligation matures, there is a chance that the pound sterling will appreciate (i.e., rise in value) against the dollar, thereby increasing the dollar price of the fabric. In response to these two undesirable alternatives, the American merchant may buy a contract in the futures market; this contract will specify that the merchant will buy ten thousand pounds at a specified rate ninety days in the future. The merchant is thereby assured of the price in dollars he will pay for the sterling exchange, without having to purchase it now. The seller of the contract is speculating that sterling will depreciate against the dollar, thereby permitting the ten thousand pounds to be supplied at reduced dollar cost.

(Main Author: William J. Miller)

Hedging in International Trade

Meaning of Hedging, according to the Dictionary of International Trade (Global Negotiator): Purchasing a future contract for delivery of a commodity or currency to reduce the risk or adverse price changes occurring from the present to the time the performance the is due. Hedging consists of counterbalancing a present sale o purchase by a purchase or sale of a similar commodity or currency, usually for delivery at some future date. The desired result is that a profit or loss on a current sale or purchase be offset by the loss or profit on the future purchase or sale. See also arbitrage.


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