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Derivatives




Long Hedge


A hedge that involves taking a long position in futures contracts so as to lock in a price. When a firm expects it will have to buy a specific asset in a certain period in the future, the long hedge will enable it to lock in the price of the required asset at the futures price quoted today.

For example, suppose a copper manufacturer predicts it will need 50,000 pounds of copper after three months to fulfill a certain order. The spot price of copper is $4 per pound and the 3-month price is $3.8. The manufacturer can hedge its position by taking a long position in two futures contracts (25,000 pounds each).

The position is to be closed after three months on a specific date. If the spot price of copper turned out to be $3.9 after the lapse of three months, the manufacturer gains 50,000 x (3.9-3.8)= $5000. Otherwise, if the spot price declined to $3.5, the hedging position will incur losses to the tune of 5,000 x (3.5-3.8)= $15000. However, any potential losses in hedging should be considered merely costs of being certain about the future.



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Derivatives have increasingly become very important tools in finance over the last three decades. Many different types of derivatives are now traded actively on ...
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