Chapter 13

Hedging Bets

In This Chapter

arrow Knowing when to hedge

arrow Choosing your exposures

arrow Monitoring and adjusting hedges

arrow Taking hedges off at the right time

In financial terms, to hedge means to reduce risk by taking on an offsetting risk. A common example is buying insurance. You bet with an insurance company that your house will burn down this year. You pay £2,000 (the premium), and if you’re right, the insurance company pays you £500,000. Considered in isolation, this bet is risky, but it still reduces your risk because the combined value of your house plus insurance policy has less volatility than the value of the house alone.

remember Although risk managers use hedges all the time, you don’t have to like them. You only consider hedging when you hold a risk you don’t want. In that circumstance, your first instinct should be to get rid of the risk. People buy fire insurance on their houses mainly because they couldn’t afford to replace them if they were to burn down. Considered as a pure risk ...

Get Financial Risk Management For Dummies now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.