STRATEGIC REASONS FOR HEDGING Financial guarantees serve an important function for virtually every player in the global economy - households, businesses, and governments.

Essay by donpablo April 2004

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Some people don't distinguish between risk and uncertainty. Risk is seen as the phenomenon which arises from circumstances where we are able to identify the possible outcome ever their likehood of occurrence without being sure which will actually occur.

Uncertainty describes the position where we are not able to identify all of the possible outcomes, and we are still less able to assessment their likehood of occurrence.


We can distingue three attitudes to risk, averse loving and neutral.

Risk-averse: in this case a person would gain less satisfaction for each additional than the satisfaction which would be lost from having 1 less

Risk-loving : there is more utility from having additional

Risk-neutral: there is not a preference for gain or loss 1 .

In general, there are most risk-averse people than loving or neutral, because of this, we deduct easily why firm hedge risk.

We can extend this idea with this other graph:

Here possibility of loss has different perspective, each has a different notion of what Value at Risk is.

Let's look at the stock issuer's perspective on risk. The issuing corporation views risk as exposure to a rising market. If the corporation had waited to issue the stock until after the market rise, it could have obtained the same amount of cash for newer shares. For the issuer, risk is a stock price that rises after it sells stock. If the stock prices the day after the shares are issued, the issuer's sale of the stock today will appear fortuitous. The investor or asset manager when thinking about Value at Risk is really focusing on price decline. So, from this example, each type of market participant has a different notion of Value at Risk measured over different time horizons and possibly different...