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Hedging
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13-Nov-13 05:19PM
Many participants in the commodity futures market are hedgers. They use the futures market to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that his corp is ready for harvesting by selling his corp forward, he obtains a hedge by locking to a predetermined price.
The are basically two kind of hedges that can be taken
Short Hedge
A short hedge is a hedge that requires a short position in futures contracts. As we said, a short hedge is appropriate when the hedger already owns the assets, or is likely to own the asset and expects to sell it at some time in the future. A short hedge can also be used when the asset is not owned at the moment but is likely to be owned in the future.
Long Hedge
Hedges that involve taking a long position in a futures contract are known as long hedges. A long hedge is appropriate when a company knows it will have to purchase a certain asset in the future and wants to lock in a price now.
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