Advantages Of Hedging

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Hedging is a process in business where an attempt is made to reduce the exposure to risk that a firm or even an individual may have. Hedging may refer to something as simple as diversification or auditing, to complex products such as derivatives. Derivatives among other hedging tools are a core part of major industries, and as a result a sufficient amount of research has been done to analyse the effectiveness of these tools, including in the energy sector. How have other hedging tools, similar or dissimilar tools, worked in the energy sector, and can ideas be drawn from other industries that could benefit JPS and other energy sectors? In Joseph’s (2000) paper The choice of hedging techniques and the characteristics of UK industrial firms,…show more content…
For example, Claessens’’s 1991 paper Hedging Crude Oil Imports in developing countries. As was noted before in Blackman’s analysis of SIDS, one very important characteristic of SIDS is they tend to have open economies, meaning because they generally have few resources, they are highly dependent on imports from other states to provide certain resources. With exceptions like Trinidad, many SIDS have to depend on crude oil imports to power their electricity sector. Previously, it was asserted that strict regulations diminishes the availability of derivatives as a feasible hedging technique, but this paper proposes how developing countries may effectively utilize hedging instruments. Twenty-four years later, the GOJ engaged in an options contract with Citibank to reduce the uncertainty of oil prices, with the intention of keeping fuel prices stable for the country. Though the GOJ received backlash from the public for the deal (and this kind of backlash was cited by Claessens’ their study as a major issue in governments engaging in derivatives products) and lost on the premium since international oil prices actually declined, it signalled a new age of the GOJ intervening in the volatility of the cost of a significant import coming into the country. Once again, a huge emphasis is made in this paper on the fact that derivatives can serve as a very useful hedging tool once a significant knowledge of derivatives is available and found among the stakeholders in this

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