Definition of Hedge

Hedge

A transaction that reduces the risk of an investment.

Hedge

A securities transaction that reduces or offsets the risk on an existing
investment position.

Additional hedge

A protection against borrower fallout risk in the mortgage pipeline.

Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

Delta hedge

A dynamic hedging strategy using options with continuous adjustment of the number of options
used, as a function of the delta of the option.

Hedge fund

A fund that may employ a variety of techniques to enhance returns, such as both buying and
shorting stocks based on a valuation model.

Hedge ratio (delta)

The ratio of volatility of the portfolio to be hedged and the return of the volatility of the
hedging instrument.

Hedged portfolio

A portfolio consisting of the long position in the stock and the short position in the call
option, so as to be riskless and produce a return that equals the risk-free interest rate.

Long hedge

The purchase of a futures contract(s) in anticipation of actual purchases in the cash market. Used
by processors or exporters as protection against an advance in the cash price. Related: hedge, short hedge

Money market hedge

The use of borrowing and lending transactions in foreign currencies to lock in the
home currency value of a foreign currency transaction.

Perfect hedge

A financial result in which the profit and loss from the underlying asset and the hedge position
are equal.

Sell hedge

Related: short hedge.

Short hedge

The sale of a futures contract(s) to eliminate or lessen the possible decline in value ownership of
an approximately equal amount of the actual financial instrument or physical commodity.
Related: Long hedge.

Hedge inventory

Excess inventories kept on hand as a buffer against contingent
events.

Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.

Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.

Covered interest arbitrage

A portfolio manager invests dollars in an instrument denominated in a foreign
currency and hedges his resulting foreign exchange risk by selling the proceeds of the investment forward for
dollars.

Cross hedging

The practice of hedging with a futures contract that is different from the underlying being
hedged.

Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying
transaction.

Delta

Also called the hedge ratio, the ratio of the change in price of a call option to the change in price of the
underlying stock.

Dynamic hedging

A strategy that involves rebalancing hedge positions as market conditions change; a
strategy that seeks to insure the value of a portfolio using a synthetic put option.

Hedgie

Slang for a hedge fund.

Hedging

A strategy designed to reduce investment risk using call options, put options, short selling, or futures
contracts. A hedge can help lock in existing profits. Its purpose is to reduce the volatility of a portfolio, by
reducing the risk of loss.

Hedging demands

Demands for securities to hedge particular sources of consumption risk, beyond the usual
mean-variance diversification motivation.

Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.

Option not to deliver

In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.

Protective put buying strategy

A strategy that involves buying a put option on the underlying security that is
held in a portfolio. Related: hedge option strategies

Put option

This security gives investors the right to sell (or put) fixed number of shares at a fixed price within
a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain
price by a certain time in order to protect, or hedge, an existing investment.

Risk controlled arbitrage

A self-funding, self-hedged series of transactions that generally utilize mortgage
securities as the primary assets.

Structured arbitrage transaction

A self-funding, self-hedged series of transactions that usually utilize
mortgage securities as the primary assets.

Unmatched book

If the average maturity of a bank's liabilities is less than that of its assets, it is said to be
running an unmatched book. The term is commonly used with the Euromarket. Term also refers to the
condition when a firm enters into OTC derivatives contracts and chooses to hedge that risk by not making
trades in the opposite direction to another financial intermediary. In this case, the firm with an unmatched
book hedges its net market risk with futures and options, usually.
Related expressions: open book and short book.

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