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Answer Posted / anjali
Hedging means reducing or controlling risk. An automobile
manufacturer purchases huge quantities of steel as raw
material for automobile production. The automobile
manufacturer enters into a contractual agreement to export
automobiles three months hence to dealers in the East
European market.
This presupposes that the contractual obligation has been
fixed at the time of signing the contractual agreement for
exports. The automobile manufacturer is now exposed to risk
in the form of increasing steel prices. In order to hedge
against price risk, the automobile manufacturer can buy
steel futures contracts, which would mature three months
hence. In case of increasing or decreasing steel prices, the
automobile manufacturer is protected. Let us analyse the
different scenarios:
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