A hedge is a transaction, which lowers risk. There are number of ways to design hedges for minimizing risk in banking corporations.
There are basically two types of hedges:
- Long hedges, in which future contract are bought in anticipation of price increases.
- Short hedges, where a firm or individual sells future contract to guard against price declines.
Recall that rising interest rate lower bond prices and thus decrease value of the bond future contracts. Therefore if a firm or individual needs to guard against an increase in interest rates, a future contract that makes money if rates rise should be used. That means selling or going short, on a future contract.
Definition 2.
Hedge- the purchase of a contract (including forward foreign exchange) or tangible good that will rise in value and offset a drop in value of another contract or tangible good. Hedges are undertaken to reduce risk by protecting an owner from loss.