HEDGING

According to investopedia, hedging is described as "Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract" (Investopedia)

From reading a bit about hedging, it seems like its a great thing for companies to do if they foresee a great deal of market fluctuations in the future. I suppose that a hedge would be considered perfect if it reduces their cost of risk to zero. Hedges can be very useful also, when companies may be just unsure of what the market is going to do in the future.

One great example of hedging that we have seen recently in the economy is that of oil. This is specifically important for companies within the airline industry because they consume so much oil. Many airlines have been able to protect themselves from rising prices for oil by locking in a specific price. Airlines are able to hedge in several ways, by making financial transactions with banks, energy companies or other trading partners.

For example, hedging has helped Southwest Airlines reduce the margin of their losses due to increasing oil prices. Though these hedging transactions can be very expensive, they can also be very beneficial. In an article from June 2008 about Southwest's oil hedging, it says "Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year." But, this hedging saved them a lot of money. In fact, "As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year's fuel needs at $51 per barrel instead of the current price of more than $140 per barrel" (International Herald Tribune).