hedge

Hedge

Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.

Notes:

An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations.

Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).

See also: Delta Hedge, Hedged Tender, Hedge Ratio, Naked Position, Pairs Trade, Short Selling

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Hedge

A transaction that reduces the risk of an investment.

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hedge

A security transaction that reduces the risk on an already existing investment position. An example is the purchase of a put option in order to offset at least partially the potential losses from owned stock. Although hedges reduce potential losses, they also tend to reduce potential profits. See also perfect hedge, risk hedge, short hedge, special arbitrage account.

Case Study A hedge that limits potential losses is also likely to limit potential gains. In May 1997 Georgia entrepreneur and billionaire Ted Turner entered into an arrangement whereby Mr. Turner had the right to sell four million of his Time Warner shares to a brokerage firm at a price of $19.815 per share. At the same time the brokerage firm acquired the right to buy the same four million shares at a price of $30.45. This particular hedge, called a collar, established a minimum and maximum value for four million shares of Time Warner owned by Mr. Turner. In other words, the former owner of the Atlanta Braves, Atlanta Hawks, CNN, and superstation WTBS acquired the right to obtain at least $19.815 per share by agreeing to give up any increase in value above $30.45. Time Warner stock subsequently skyrocketed when America Online acquired the firm at a price nearly triple the $30.45 stipulated in the agreement. Thus, the hedge ended up costing Mr. Turner approximately a quarter of a billion dollars. On a positive note, the four million shares represented less than 4% of Mr. Turner's total holdings of Time Warner stock he had acquired when the firm bought his Turner Broadcasting several years earlier.