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Hedging

Definition of Hedging

Hedging is a risk management technique where potential loss is offset by securing a safer, more stable trade. For example, buying stock (risky) and offsetting the risk with commodity (stable) is a common hedging practice in the securities market.

In the derivatives market, hedging is followed by merchants and businesses who want to protect against adverse price movements in commodities or currencies. They do so by entering into a futures or options contract.

Related Terms

Cash Ratio

A cash ratio measures a company’s ability to fulfill short-term debt obligations using only its cash and cash equivalents, which are known to have high liquidity. The formula for calculating cash ratio is:

Cash Ratio: Cash + Cash Equivalents / Current Liabilities

Circuit Breaker

A circuit breaker or market curb is a measure that exchanges use to put a stop to all trading activities across an index or entire market. This regulatory measure is put in place to curb panic selling, especially when markets are in free fall.

That’s why circuit breakers are also known as trading curbs and are put in place when an index or market reaches a specific level. These are the current circuit breaker limits on NSE:

Circuit Breaker Trigger Trading Halt Duration
10% 0-45 minutes
15% 45 minutes; 1 hour 45 minutes; rest of the day
20% Rest of the day

Lead Underwriter

The lead underwriter is a financial institution that is in charge of ensuring that an IPO is successful on the primary market. Companies may also hire lead underwriters to carry out a FPO.

CANSLIM

CANSLIM is an acronym for a seven-step strategy to pick growth stocks by combining fundamental and technical analysis. Here’s the full form of CANSLIM:

  • Current quarterly Earnings Per Share (EPS): compare this fundamental indicator with the same figure from the previous quarter. If the figure grows (by 20% or more as a rule of thumb), the company is fundamentally strong.

  • Annual earnings: Compare this fundamental indicator from the previous years. If there’s year-on-year growth, the company is fundamentally strong. If the year-on-year growth is by 20-25%, even better.

  • New product or service: strong companies continue to innovate. That’s what this letter is about - checking if the company is continuously launching new products, services, or holding events.

  • Supply: a fundamentally strong business should have a good supply and demand when it comes to its goods, services, and stock. Executive supply of shares may reduce the value of the company - that’s why it should always be scarce in supply.

  • Leader: the company should be a leader in its own right, either in or across industries.

  • Institutional holding: a valuable company will have higher institutional ownership, the percentage of which should always be tracked.

  • Market trend: an investor must check whether the company or stock is going or against the trend by comparing it to broader indices.

Consolidated Financial Statements

A consolidated financial statement is a record of all the assets, liabilities, income, expenses, and other financial data of a company and its subsidiaries.

Discounted Cash Flow

Discounted cash flow is a method of valuing a company in the present based on future cash flows. An investment may be profitable in the present if the discounted cash flow is above the current cost of investing.

The formula to calculate discounted cash flows is:

DCF = Cash Flow Year 1 / (1+r1)^1 + Cash Flow Year 2 / (1+r2)^2 + Cash Flow Year N / (1+r)^n



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