The activities of any company operating in the financial resources market are associated with huge risks of losses due to abrupt changes in market conditions. Market behavior is very difficult to predict in advance, in addition, at any second it can be influenced by factors such as natural disasters, political conflicts and other troubles. Risk hedging is used by financial market players in order to be able to insure themselves as much as possible against loss. About how such insurance is carried out, we will describe in this article.
Hedging financial risks can take various forms, depending on what goals the trader is pursuing. One of the most primitive types of hedging is the opening of two multidirectional transactions for one instrument - thus, the loss from market movement resulting from one transaction is compensated by the profit from the same movement from another transaction. Naturally, this strategy eliminates not only losses, but also profits, thereby significantly reducing both risk and the effectiveness of the market. A more complex version of this strategy is the conclusion of transactions with various instruments - for example, you can conclude a deal on the shares of a certain company and on the stock index, which is also formed taking into account the price of acquired shares. Naturally, in order for the risk hedging not to take all the profit, the volume of the main transaction must exceed the volume of the insurance counter transaction. Thus, reducing the level of profit at the first stage of the transaction, we also reduce its loss ratio until we become confident that the price trend we need has been established. After that, the insurance transaction can be closed, thereby increasing the profitability of the operation.
Risk hedging has other forms, the most popular of which is the conclusion of transactions with deferred performance agreements - the so-called forwards. A forward is a contract that stipulates the price and delivery time of the goods, which, as a rule, is six to twelve months from the date of conclusion. Thanks to this, the parties agree in advance on the purchase and sale of goods on conditions that satisfy their interests at the moment, and in the future they will not be worried about changes in the market price for the subject of the transaction. The first forward agreements concerned the supply of agricultural products, the prices of which are subject to changes due to the influence of natural factors, and as a result, changes in the volume of the crop. The standardized type of forward contract is the so-called futures contract, in which the conditions, delivery time and quantity of goods are established in advance by the rules of the exchange.
Risk hedging can also be carried out through the purchase of options. An option gives its buyer the right (not an obligation, as in the case of a forward or futures) to purchase or a certain amount of an asset after a certain date. This type of contract is most beneficial for the buyer, since if the use of the option right is not beneficial for him, his loss will be equal only to the value of the option itself. The seller is also in a winning situation - the value of the option is for him a kind of advance bonus for the transaction, which may not take place.
Hedging risks is an integral part of the strategy of any exchange player. In an ever-changing market environment, playing the stock exchange without risk insurance is like suicide, which is why counter-transactions and transactions with derivative financial instruments occupy a significant share among financial transactions around the world.