Hedging Risk Management
Risk management is one of the most important skills that a corporation must acquire if it is to succeed in today’s market place. The media often talks about companies hedging risk management, which sounds like so much business jargon to the man on the street, so this article will attempt to clarify what is hedging risk management and why companies do it.
Hedging Risk Management: In financial terms, a hedge is where a company enters a more stable market when some of their stock is in a market that is subject to large fluctuations. For example, buying shares in a big multinational corporation is a fairly steady bet, whilst trading on the currency exchange market is typically more volatile due to more public exposure. A company will engage in hedging as a form of risk management when they wish to invest in an idea or a country, rather than in a specific company or specific currency. Entering a volatile market is more likely to pay off big dividends in the long run, but in the short term stock and share prices can plummet dramatically during a day’s trading, which could effectively wipe out a company’s assets. By hedging in a more stable environment, the company effectively insures against any big losses by making assured, but small, gains.
Hedging risk management is not a 100% secure method by any means. For many decades, companies will have formed hedges in BP as a long term company whose stock prices tend to be fairly consistently rising. The recent events in the Gulf of Mexico however have seen BP’s share price drop dramatically, which is causing large problems in the hedging risk management sector. On the one hand, companies want to keep their stock in BP because it will re-stabilize eventually, and if everyone sold their stock, the company would founder even more. However, making a loss on two fronts is not favorable either. So hedges have to be chosen with great care.