Question

List and explain two arguments against hedging and two arguments for hedging.

(Each explanation should be no more than 4-5 line short paragraph)

Answer 1

Advantages of Hedging:

- It provides a sense of relief to producers who can fix the selling price of their product through hedging. Price of a commodity constantly change in the market. Slight unfavourable movement can lead to huge losses. So derivative market can be used to hedge the position and fix the selling price. It gives producers the courage to enter into production, without the fear of incurring losses.

- There are several derivative strategies that can be formulated for hedging purpose, which can help traders to maximise profit. So by entering into complex strategies, both the risk is mitigated and also the profit is maximised in an efficient way.

Disadvantages of Hedging

-Hedging may involve buying options in derivative markets. Options are not free of cost. So to buy option you need to pay premium. This reduces the total profit that you were expected to earn from the transaction.

- As you fix the price in hedging, so you forgo the favourable price movement opportunity. If you have already fixed a selling price and the price actually moves higher, then you can't sell your product at higher price in market as you have already fixed a contarct.