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Hedge

Meaning: 

A Hedge is defined as a financial strategy that aims to protect an investor from potential losses associated with an investment. It operates similarly to an insurance policy for an investment portfolio, providing a means to mitigate risk. In simple terms, hedging is the practice of reducing risk exposure in financial markets.


Example:
For instance, if you invest ₹1,00,000 in Nifty stocks and anticipate a market decline, you might purchase a Nifty Put option. If the market falls, while your stocks decrease
in value, the Put option gains profit, thus offsetting some of your losses. This protective measure is known as hedging.

How to understand Hedging:

Hedging is crucial for reducing risk during periods of market volatility and helps protect profits already earned.
It is particularly beneficial for large institutions, traders, exporters, and importers who face various financial risks.


Importance of Hedging:

Hedging does not guarantee profit but serves to minimize losses, providing a more stable investment environment.

Types of Hedging:

Futures Hedging:
Involves using futures contracts to lock in prices (e.g., buying Nifty futures to protect a stock portfolio.

Options Hedging: 
Involves using Call or Put options to limit potential losses (e.g., buying Put options to hedge against stock declines).

Commodity Hedging:
Protects against price movements in commodities like crude oil, gold, and metals.
Currency Hedging:
Aims to avoid foreign exchange losses in currencies like USD, EUR, and JPY.
Interest Rate Hedging:
Employed by banks and corporations to hedge against fluctuations in interest rate.

Portfolio Hedging:
Involves using various financial instruments to protect long-term investments from market risks.

How Hedging Works: :

For example, if you invest ₹1,00,000 in Nifty stocks and fear a market decline, you might buy you might buy a Nifty Put option. If the market falls:
Your stocks lose value, but the Put option gains profit.
The loss in your stock investment is offset by the gain in the hedge, thus reducing your overall risk.

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