hedging

The Columbia Encyclopedia, 6th ed.

hedging

hedging, in commerce, method by which traders use two counterbalancing investment strategies so as to minimize any losses caused by price fluctuations. It is generally used by traders on the commodities market. Typically, hedging involves a trader contracting to buy or sell one particular good at the time of the contract and also to buy or sell the same (or similar) commodity at a later date. In a simple example, a miller may buy wheat that is to be converted into flour. At the same time, the miller will contract to sell an equal amount of wheat, which the miller does not presently own, to another trader. The miller agrees to deliver the second lot of wheat at the time the flour is ready for market and at the price current at the time of the agreement. If the price of wheat declines during the period between the miller's purchase of the grain and the flour's entrance onto the market, there will also be a resulting drop in the price of flour. That loss must be sustained by the miller. However, since the miller has a contract to sell wheat at the older, higher price, the miller makes up for this loss on the flour sale by the gain on the wheat sale. Hedging is also employed by stock and bond traders, export-import traders, and some manufacturers. See also hedge fund.

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