Definition of Hedging

Definition of Hedging – Setting up an investment positions which helps to protect against losses from a related investment.

For example, if you export goods to the US, an appreciation in the exchange rate can make your exports uncompetitive. Therefore, you can hedge against your position by buying Sterling futures. If sterling appreciates, your exports become uncompetitive, but you benefit from the rise in the value of Sterling.

When weighing up what to buy and where to invest some speculators may wish to hedge against risky investment.

A simple way to engage in hedging is to buy a safe asset for every risky asset. However, some people may want to hedge against a particular investment. This can be done by using derivatives.

Hedging with Put Options

An example is using a put option. This gives the owner the right, but not the obligation, to sell at a certain fixed price, before a certain date.

This means that if the share price falls more than the agreed price (striking price) then you can sell it.

Example, suppose you buy shares in ICI for 100p, hoping they will increase in value. To hedge, you could also take out a put option, which gives you the right to sell shares in ICI for 80p in the next 6 months. This means that if shares in ICI fall by 30%, the investor can sell at 80p.

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Police and Fire Services as Public Goods

Q. Use economics and political theory to explain why the fire and rescue service should be provided by the state. I don’t want the answer….I just don’t understand what this means.

This revolves around a fundamental debate in economics – How much should the government intervene in the economy?

Ideally, goods and services would be provided in a free market without requiring any government intervention. Market provision is considered superior because there is less bureaucracy and more incentives for firms to be efficient.

However, there are some goods and services which will be under-provided in a free market. (Some goods may not be provided at all). This is considered a type of market failure and therefore for several reasons people argue the government should step in and provide it.

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Sticky Inflation

Sticky inflation is an undesirable economic situation where there is a combination of stubbornly high inflation, (and often stagnant growth).   Sticky inflation is often associated with cost-push factors, i.e. factors which cause a rise in the inflation rate but also lead to lower spending and economic growth. Sticky inflation is also sometimes known as Stagflation …

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Will the US economy enter into Recession in 2008?

Back in March I wrote this essay – Is the US heading towards recession?

According to some doom mongers the US is already in recession. They point to the ‘collapsing’ housing market and the rise in ‘repossessions’
The irony is that US economic growth has remained unexpectedly high at 4.9% in 3rd quarter of 2007. Growth has averaged over 2.1% since 2001 (US economic snapshots)

Unemployment remains at 4.5%, although this masks some disguised unemployment, – it is hardly the sign of a full blow recession.

Nevertheless there are several warning signs that could push the US into recession by the end of 2008

Why US Recession is Likely

House Price Fall.

US house prices fell by 4.5% in 2007. (In some cities they fell by more). Falling house prices reduces consumer wealth and consumer confidence; this will lead to lower spending. (Consumer spending has been the main driving force behind the US economy in recent years)
There are also concerns that the fall in house prices could accelerate due to the glut in house supply and the fact more people are coming to the end of cheap mortgage terms.

House Repossessions.

There has been a record rise in home repossessions. The foreclosure rate on homeowners has risen to a 17 year high of 5.59%.

Global Credit Crunch

Due to mortgage repossessions, especially on sub prime mortgages, banks have had to write off a lot of bad debts. This has caused an increase in the cost of lending. For example, 3 month dollar Libor spreads have jumped by 60 to 80 basis points in recent months.

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Imports – Exports and the Balance of Payments

Readers Question: What counts as an import on the Balance of Payments?

Current Account measures trade in:

  1. Goods,
  2. Services,
  3. Investment incomes
  4. Net Transfers

A Debit on the credit account occurs when the UK imports goods and therefore money flows from the UK to oversees to purchase it. If debits are greater than credits the UK will have a current account deficit.

Examples of debits

  • UK consumers buy Chinese manufactured toys
  • UK consumers go on holiday to China
  • A Chinese firm in the UK sends back profits to China.
  • UK firms import raw materials from China.

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UK Unemployment in 2007 lowest for 22 years

Amidst all the gloom surrounding global credit markets and house prices, it is easy to forget some of the strengths and developments in the UK economy. One of the most remarkable features of the UK economy is the sustained reduction in unemployment. Falling from a peak of 3 million in 1992, the official method of …

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OPEC and Oil Prices in 2008

Readers Question: What will happen if OPEC continued to increase oil prices?

Firstly, the rise in the price of oil is not just due to the activities of OPEC. It is partly due to the rising demand from countries such as China.

If OPEC continue to contribute to higher oil prices in 2008 it would have the following effects.

Oil Exporting Countries.

  • Higher prices would lead to higher oil revenues. This would improve their current accounts and also government finances.

Oil Importing Countries.

  • Would see a deterioration in their current account deficits.
  • Inflation. – Higher oil prices is likely to lead to cost push inflation. This is because the price of oil effects the cost of producing many different goods.
  • Economic Growth. Economic growth may slowdown if oil prices continue to rise. However, it would have to be  a fairly significant rise in prices to have a permanent effect.

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Categories oil

Costs and Benefit of Tescos

Readers Question Is tesco’s power a net benefit or a cost to the wider economy?

In the UK, Tesco have over 32% of market share for supermarkets. It is a similar situation as the US, where supermarkets are dominated by Walmart. Tesco is now the largest private sector employer in Europe. (working for Tesco)

It is an emotive issues whether Tesco is Good or bad for society and consumers.

Benefits of Tesco

1. Economies of Scale.

The large size of the firm means that it can benefit from economies of scale in areas such as bulk buying, transportation, distribution, marketing and technology. Economies of scale mean higher output leads to lower average costs and lower prices for consumers.

2. Diversification

The large size and financial resources of Tescos means that it has been able to diversify into other products such as Mobile Phones, insurance, petrol, credit cards and banking. In these areas, Tesco has helped to increase competition, provide more choice and help lower prices for consumers.

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