we look at what hedging is and discuss whether or not it is an advantageous venture for SMEs.
It’s no secret that there has been a lot of economic and political turmoil in regard to the global economy recently. This turmoil has led to extremely volatile currency markets, which has had an impact on virtually every aspect of the business world. While all businesses have been impacted by the current state of global economic and political affairs, the organisations that seem to have been hit the hardest are those that conduct business across borders, as well as small businesses.
Whereas large corporations have the ability to cope with the burden of the current state of economic and political affairs, small and medium enterprises (SMEs), including import-export companies, farmers and retailers are not. In fact, drastic shifts in the economy can be the difference between profitability and bankruptcy for SMEs.
Given the current state of the global economies, many small business owners are wondering if they should get involved in hedging. Here, we will have a look at what hedging is and discuss whether or not it is an advantageous venture for SMEs.
Hedging refers to the process of making an investment to reduce the risk of negative price movements in an asset. For instance, if you own a stock in a certain company and you enter it into a futures contract, indicating that you will sell the stock at a set price, you will be able to avoid or moderate any fluctuations in the market. Investors utilise this strategy when they are not sure what the market will do. If done correctly, a hedge can reduce your risk to nothing (minus the cost of the transaction fees.)
Hedging can be done through a number of different tools, including:
There are several benefits that hedging can offer an investor. The first and the most important benefit is that hedging can eliminate risks, and actually significantly reduce them. However, it should be said that hedging is not a 100 per cent guarantee; nevertheless, with the right guidance, it is certainly a way to significantly reduce risks.
Another benefit of hedging is that is can help to manage the costs that are related to commodities, including fuel and raw materials. As a result, the process of hedging creates a larger bottom line, thus increasing profitability.
If you think hedging is something that you would be interested in, but you have limited resources, don’t despair. There are strategies that can be put in place that will allow you to invest in a smaller percentage of the total amount that needs to be covered, which is done via leveraging, or ‘trade on margin’. In other words, the total necessary investment to cover £500,000, for example, may only be £5,000 based on a leverage quota.
While hedging can be advantageous, there are potential risks. For instance, if the market moves against you, there has to be enough money in your reserve fund to cover the margin payment if you end up having to close out of your position.
Hedging reduces the risks that are created as a result of a volatile global economy. Hedging can prove to be a beneficial move if you are an SME, as it can help to soften the hit that is brought about by when an SME is exposed to extreme external factors.
To determine if hedging is right for you, you should define your risk tolerance. If it turns out that hedging would be beneficial for your business, you’ll find that it could be the difference between profit and loss.
3 ways financial hedging can help your business sustainability
Financial hedging is an investment strategy which is aimed at minimising the level of risk that investors are exposed to. Hedging is a form of diversification, this means that the individual or company who is looking to hedge their investment will spread it out, or diversify it, over a number of different investment opportunities.
The aim of doing this is to limit the damage of any one investment failing, the idea being that by having multiple investments on the go, should one fail, the others will minimize or absorb the losses entirely. Both diversification, and in particular hedging, have long been popular strategies among investors who are either more cautious, or simply willing to wait longer for their return.
The most obvious downside to hedging is that investors will need more capital to see the same level of returns. This is because while they are investing in more options, they are investing less in each one and as such each needs to mature to a greater degree to generate the same returns.
Generally speaking, hedging investments mean that they take longer to mature, but that they are less likely to be lost before that happens. In this article we take a look at three of the key ways in which financial hedging can help to improve a businesses sustainability.
Diversifying your company’s holdings doesn’t just shield you from the potential headache of one of your investments turning bad, it also means that you will have more opportunities to turn a profit. Only by hedging your assets in a variety of different holdings can you position yourself to benefit from any synergy between markets.
Without hedging, you can only benefit from upswings in the single market that you choose to invest in. With hedging you might see a smaller return, because you will have invested less money in each holding, but the fact that you are more likely to see a return at all is enough reason for many businesses to opt for financial hedging.
Hedging is an excellent way of minimising the risk of being hit by a bad investment, however it is a long way from being a perfect solution. Whenever you are investing your money, even if you are storing it in a bank, you are taking some level of risk. With hedging that risk is reduced and, should you find that you suffer losses on your investments, hedging makes it far less likely that such losses will cripple your business.
Hedging is a tried and tested method for protecting a business from potential losses and of improving overall sustainability. If you think that your business could benefit from hedging, then be sure to familiarize yourself with how it all works before embarking.
This is the biggest selling point of financial hedging and it is worth taking the time to understand exactly how this aspect of it works and how it is achieved. Imagine that your business has £1000 of assets that it wants to protect. There are a number of ways that the business might go about this, they could simply deposit the money in a bank and leave it there. The problem with simply leaving it in the bank is that it is then not dong anything for the business, and what’s the use of making money if it isn’t going to do anything with it?
Investing the money is risky because the investment could turn bad, thus exposing the business to more risk. By hedging, and investing the money across a range of different options, a business can shield itself from the fallout of an investment going awry.
If you are considering hedging, you should make yourself aware of the different forms the practice can take, there are a number of different financial products, such as hedging strategies with financial derivatives, each of which is best suited to different scenarios.