, individual investors and corporations to reduce risk exposure in anuses one investment to minimize the negative impact of adverse price swings in another.
Portfolio hedging typically entails the use of financialderivatives(options andfutures) to curtail losses. For example, an investor worried about short-term price swings in ABCstockcanhedgetheir stock portfolio against short-term losses by purchasing the same number of ABCputoptions. A decline in the value of ABCbe hedged, oroffset, by profits from the put options.
There are a wide assortment of options andfutures contractsthat an investor can hedge against nearly every type of risk. For example, hedges can be created to protect a portfolio from stock andcommodityprice movements, interest rate changes andcurrencyswings.
The purpose ofportfolio hedgingis to curtail potential losses. This safety also comes at a price, sincehedgingalso limits potential profits. Everyhedgehas a cost, so investors should weigh the costs of the hedge against its benefits. For mostbuy-and-holdinvestors, hedging is unnecessary, since short-term price swings in a portfolio wont matter.
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