20.3 Managing Risk by Hedging with Forward Contracts
The term hedging refers to a strategy designed to offset the exposure to price risk. For example, if you know that you are going to need to purchase 100,000 barrels of crude oil in one month but are concerned that the price of crude oil might rise over the next 30 days, you might strike an agreement with the crude oil seller to purchase the oil in one month at a price you set today. In this way, any increase in the market price of crude oil will not affect you because you have a prearranged price set today for a future purchase. This contract is called a forward contract. Let’s see how this works.
As discussed in Chapter 19, a forward contract is one in which a price is set today for an asset ...
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