Hedge

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Hedge

A transaction that reduces the risk of an investment.

Hedge

To reduce the risk of an investment by making an offsetting investment. There are a large number of hedging strategies that one can use. To give an example, one may take a long position on a security and then sell short the same or a similar security. This means that one will profit (or at least avoid a loss) no matter which direction the security's price takes. Hedging may reduce risk, but it is important to note that it also reduces profit potential.

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.
References in periodicals archive ?
The item being hedged must be identified no more than 35 days after the hedging transaction; see Regs.
Gains and losses on derivative instruments are either offset against corresponding gains or losses of the hedged item through earnings in a fair value hedge, or accounted for in other comprehensive income for a cash flow hedge.
In light of this ruling, it may be advisable for taxpayers to review their treatment of interest-rate swaps and determine if they have been under-or overreporting gain or loss from terminated hedged transactions.
When the entity designates a derivative as a fair value hedge, generally accepted accounting principles require that the entity adjust the carrying amount of the hedged item for the change in the hedged item's fair value that is attributable to the hedged risk.
He said such volatility is mitigated by the amendment provisions permitting the recognized items to be designated as hedged items.
In the absence of any statement including such receivables as "ordinary property" capable of being hedged, needless confusion and controversy may arise.
It was not necessary that every element of its interest rate risk be hedged.
The method used must reasonably match the timing of income from the hedging transaction with the timing of income from the item being hedged.
SFAS 52 allows for hedge accounting when the hedged item exposes the company to risk, the hedging transaction reduces the exposure to risk and the company designates the hedging transaction as a hedge.
Thus, eligible hedged items are limited to property within the exceptions to tax code section 1221 (such as inventory and accounts receivable) as well as specialized properties (such as debt securities held by a bank) that are capital assets but, nevertheless, produce an ordinary gain or loss on sale.
In fact, the term 'hedge fund' is a bit of a misnomer because investors may be led to believe that strategies are hedged to mitigate risk.
SFAS 80 prescribes a correlation test between the hedged item and the hedging instrument that requires a company to examine historical relationships and to monitor the correlation after it executes the hedging transaction.