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Finance Questions: Hedging

11.3 You have learned about a number of ways of reducing risk, specifically hedging, insuring, and diversifying. In the table below, place an X in the cell for the technique being used to reduce risk. For each of the following below, identify if it is a strategy for hedging, insuring, or diversifying?
1. Placing an advance order with Amazon.ca, which agrees to charge you the lower of the advance price, and the price at the time your order is filled.
2. Purchasing a call option on a stock you think may go up in price.
3. Selling 200 shares of IBM and buying a mutual fund that holds the same stocks as the S&P index.
4. Selling a debt owed to you for $.50 per dollar owed.
5. Agreeing to a long-term contract with a supplier at a fixed price.
6. Agreeing to a no-trade clause with the sports team that employs you.
7. Buying a Mac and a PC.
8. Paying a clown to perform for your child's birthday party six months before the birthday.

11.4 Suppose you own 100 shares of Dell Inc. stock. Today it is trading at $15 per share, but you're worried Michael Dell might retire again, causing the price to go down. How would you protect yourself against his retirement, assuming you don't want to sell the shares today?

Solution Preview

Response to question 11.3

Hedging is a risk management method used to reduce your risk of the price increasing in the future.
Insuring is a risk management method used to reduce your risk by moving the risk to a third party.
Diversification is a risk management method used to mitigate risk by spreading risk over a variety of assets.

1 is an example of hedging your risk of a higher price by placing the order today.
2 is an example of hedging towards more profit by buying a call option. The hope is that the stock will increase in value.
3 is an example of diversifying your portfolio by increasing the number of stock from IBM to the 500 companies in the S&P index.
4 is an example of insuring risk management by passing a debt onto a third party. At the same time, you have collected ...

Solution Summary

The expert examines hedging for finance questions. Advanced orders with Amazon.ca are determined.

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