4.14.2005

Q&A: How does the investment strategy of a speculator...

...differ from that of a hedger?

A:

A speculator increases expected return by increasing risks. In a well-functioning market, increased risk is associated with increased expected return.

A hedger increases expected return by dereasing pre-existing risks even though doing so may decrease returns. For example, supports Microsoft, who accounts for its profit and loss in US dollars, is expecting to receive 1 billion British pounds in three months. To hedge the risk of dollar appreciation, it can lock in the exchange rate by engaging in a forward contract with an investment bank (who in turn can offset its new risk with a transaction with another party.)

Category: C++ Quant > Derivatives

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