What is Hedging?

What is Hedging? Hedging: A risk management tool that is designed to limit exposure to risk as part of everyday business. Hedging explained through a wheat farmer example: $4.50 per bushel Wheat Price 2 Farmer Sets Target Price for Harvest Farmer and Baker Consider Price Fluctuations Farmer and Baker Use a Hedge to Reduce Risk The Hedge Manages Risk A Farmer Prepares A Wheat Crop 45 55 A farmer purchases fertilizer, fuel, seed and everything else necessary to grow a wheat crop. Based on all his costs, the farmer determines a price he'd like to get for the wheat when he sells it to a local bakery at By creating a hedge, the farmer and baker managed the risk of fluctuating wheat prices. If the market price at harvest is higher than the set price, the baker benefits from the hedge. If the price is lower, the farmer benefits. In either case, the hedge protectedboth against the potential for serious losses. The farmer is concerned that wheat prices will go down, and he won't make enough to cover his costs. The baker is concerned that The farmer and baker agree in advance to a set price for the wheat, regardless of the market price at harvest time. harvest time. wheat prices will go up, and he'll have to raise prices. 8 Partnership for a secure financial future www.ourfinancialfuture.com