Question

You are a treasurer of Oriflame, what are the different hedging strategies available to Oriflame? Which one would you choose? and why?

Answer 1

Hedging

• The best way to understand hedging is to think of it as a form of insurance. When people decide to hedge, they are insuring themselves against a negative event's impact to their finances. This doesn't prevent all negative events from happening, but something does happen and you're properly hedged, the impact of the event is reduced.
• In practice, hedging occurs almost everywhere, and we see it every day. For example, if you buy homeowner's insurance, you are hedging yourself against fires, break-ins, or other unforeseen disasters.
• Portfolio managers, individual investors, and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging is not as simple as paying an insurance company a fee every year for coverage.
• Hedging against investment risk means strategically using financial instruments or market strategies to offset the risk of any adverse price movements. Put another way, investors hedge one investment by making a trade in another.
• Technically, to hedge you would trade make offsetting trades in securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.
• For instance, if you are long shares of XYZ corporation, you can buy a put option to protect you from large downside moves—but the option will cost you since you have to pay its premium.
• A reduction in risk, therefore, will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you have typically reduced your potential profit, but if the investment loses money, your hedge, if successful, reduces that loss.

How do hedging strategies work?

Hedging is the balance that supports any type of investment. A common form of hedging is a derivative or a contract whose value is measured by an underlying asset. Say, for instance, an investor buys stocks of a company hoping that the price for such stocks will rise. However, on the contrary, the price plummets and leaves the investor with a loss.

Such incidents can be mitigated if the investor uses an option to ensure that the impact of such a negative event will be balanced off. An option is an agreement that lets the investor buy or sell a stock at an agreed price within a specific period of time. In this case, a put option would enable the investor to make a profit from the stock’s decline in price. That profit would offset at least part of his loss from buying the stock. This is considered one of the most effective hedging strategies.

Below are the hedging strategies for Oriflame

1. Diversification

The adage that goes “don’t put all your eggs in one basket” never gets old, and it actually makes sense even in finance. Diversification is when an investor puts his finances into investments that don’t move in a uniform direction. Simply put, it is investing in a variety of assets that are not related to each other so that if one of these declines, the others may rise.

For example, a businessman buys stocks from a hotel, a private hospital, and a chain of malls. If the tourism industry where the hotel operates is impacted by a negative event, the other investments won’t be affected because they are not related.

2. Arbitrage

The arbitrage strategy is very simple yet very clever. It involves buying a product and selling it immediately in another market for a higher price; thus, making small but steady profits. The strategy is most commonly used in the stock market.

Let’s take a very simple example of a junior high school student buying a pair of Asics shoes from the outlet store that is near his home for only $45 and selling it to his schoolmate for $70. The schoolmate is happy to find a much cheaper price compared to the department store which sells it for $110.

3. Average down

The average down strategy involves buying more units of a particular product even though the cost or selling price of the product has declined. Stock investors often use this strategy of hedging their investments. If the price of a stock they’ve previously purchased declines significantly, they buy more shares at the lower price. Then, if the price rises to point between their two buy prices, the profits from the second buy may offset losses in the first.

4. Staying in cash

This strategy is as simple as it sounds. The investor keeps part of his money in cash, hedging against potential losses in his investments.

We can choose any one from this but it will depends on the situation. As a treasurer of Oriflame, i will choose diversification. Because it is one of the most important hedging strategy to all kinds of company and business.