Hedge

A hedge is a financial strategy that offsets the risks from one security (or other investment) by buying or selling others. A common example is the use of options and futures to reduce the risks of holding a portfolio of investments.

A hedge may be static or dynamic. A hedge may also be reversed to replicate the cash flows of a security, thus, by the law of one price, allowing one to value the hedged security in terms of the securities used to hedge it. If there are discrepancies, the hedge can he used to exploit an arbitrage opportunity.

Foreign exchange futures are also very commonly used by importers and exporters who would otherwise be faced with a very high level of short term risk from exchange rate fluctuations.

More complex hedges are used and can involve the use of complex financial instruments and large numbers of transactions to provide effective hedges at the lowest cost. Some securities may only be hedged with a dynamic hedge, or by the use of a large number of other securities.

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