A hedge is an investment that has a similar purpose as that of insurance. The purpose is to eliminate or reduce the risk by offsetting the potential loss. If we are reducing the risk through hedging, then we might reduce the reward also. In the case of insurance, we pay a premium, and we might not even get any benefit from the premium if there is no flood during the tenure of the policy. Similarly, it isn’t free either. We have to pay a cost for it, which reduces the overall rewards which we get. Normally, a hedge consists of taking an offsetting position in a related security, which offset the risk of any adverse price movements. It can be done through various financial instruments such as forward contracts, futures, options, etc.
