Question

Hedge Transaction Types Briefly explain, in your own words, three of the hedge transaction types. Describe in which situations each would be used and why.

Answer 1

A hedge is an investment that protects your finances from a risky situation. Hedging is done to minimize or offset the chance that your assets will lose value. It also limits your loss to a known amount if the asset does lose value. It's similar to home insurance. You pay a fixed amount each month. If a fire wipes out all the value of your home, your loss is the only the known amount of the deductible.

1 Gold is a example of hedge if you want to protect yourself from the effects of inflation. That's because gold keeps its value when the dollar falls. In other words, if the prices of most things you buy rises, then so will the price of gold.

2 For example, if you buy homeowner's insurance, you are hedging yourself against fires, break-ins, or other unforeseen disasters. ... Hedging against investment risk means strategically using financial instruments or market strategies to offset the risk of any adverse price movements.

3 For example, if you own stock in ABC Widget Corp., and are reasonably bullish on the company but are bearish on the widget industry, you can protect some down performance in your stock by purchasing a put option on ABC Widget stock, thus providing you with the right to sell ABC Widget at a specific price at a specific time. That way, if ABC Widgets declines below the price you've set with your put option (called the strike price) you'll make some of the money back by the profits you've earned on the put option.