What is hedging & speculation?
Hedging acts as a protection in the forward markets where the transactions are to be honoured on a pre-determined future date. For example, let us suppose that Investor A have a bond and he promises Investor B to sell this bond after two months at Rs 2,000. Now after two months, if the price of the bond happens to be Rs 1,500 (or Rs 2,500), in the either cases, the Investor A has to sell the bond at the pre-determined rate of Rs 2,000. Hedging, on one hand protected the Investor A from the loss in the future value of the bond and on the other hand, restricted him from earning extra profit. Usually, hedging is more popular in the share (stock) markets and foreign exchange markets, as these markets are very volatile and are subjected to unexpected price fluctuations. The practice of Hedging protects the buyers from price (stock prices or exchange rate) hike and the sellers from reduction in price (stock prices or exchange rate).
Speculation is the process of buying and selling a (say) commodity with the element of risk for the purpose of earning profits. For example, speculation in the foreign exchange market implies buying and selling of foreign currency with a view to fetch income or gain. If an Indian investor expects an increase in US dollar with respect to Indian rupee, then he wishes to hold dollars. If his expectation turns out to be true, then he will make profits by selling US dollar at higher price in the future, else incurs heavy loss.
Hedging v/s Speculation
The main difference between hedging and speculation is that while the former aims at reducing the risk related to the price fluctuations (or price volatility), on the contrary, the latter (speculation) aims at earning profits by predicting the price directions (up or down) of the securities.
Secondly, although hedging prevents the hedgers to incur any loss, it simultaneously restricts the hedger from earning any gain. On the contrary, the speculation subjects the speculators to both favourable (upwards) and unfavourable (downwards) price movements. Speculation can lead to both profit and loss associated with the upward and downward price movements.
Thirdly, the practice of Hedging involves minimising (or eliminating) risk. On the other hand, the practice speculation involves acute risks (may be profit or loss), if the expectations of the speculators does not materialises.
Speculation is attempting to benefit from a change in price. Buy low, sell high.
Hedging is looking to eliminate or reduce exposure to a particular sort of risk. For example, a multi-national corporation may hedge transactions done in foreign currencies to eliminate the risk of adverse exchange rate moves.
- Used to reduce risk and manage margins
- Reduces the fluctuations in propane prices for retailers and end users
- Used to "back to back" sales to residential/commercial customers at a fixed profit margin
- An important part of managing and growing your retail propane company
- "Betting" the market will move in one direction
- Retailers buy product on a fixed price but charge market-based prices to their consumers
- Speculation increases risk and creates uncertainty on retail margins
- Can literally put you out of business