Planning ensures that your goals are met.
Risk Management protects your assets.
Portfolios are built with Modern Portfolio Theory.
I. Hedging a. Hedging risk
The purpose of hedging is to protect an investment from downside risk.
Hedging is the process of reducing or eliminating risk in a particular investment. The risk is hedged with an offsetting investment: a short or a derivative instrument like an option or future. If a perfect hedge does not exist, an instrument with a high correlation (the closest substitute) can be used. The inherent risk in individual investments can be 100% hedged or 10% hedged or anywhere in between.
Derivatives can also be used to leverage an investment. For example if $100 is invested in the S&P 500 and it appreciates by 1%, $1 is earned. Investments can be made to increase the leverage of a 1% appreciation to a 10%, 40% or 100% gain (or loss).
Extremely high volatility signals potential risk of loss, while extremely low volatility signals the possible loss of opportunity. When volatility changes from an extreme that may signal an "inflection point" a potential opportunity. Investments are priced based on future expectations, forecasting which investments should be bought and sold and the robustness of those investments becomes the strategic and tactical responsibility of those making investment decisions.
d. Hedged Asset Classes
Bonds have a low (or negative) correlation with stocks.
Natural Resources stocks have a low (or negative) correlation with stocks.
International (Emerging market) Small Cap stocks have a low correlation with US stocks.
e. Hedging instruments
Futures - Interest rate, Currency & Commodity.
Forwards - Interest rate, Currency & Commodity.
Swaps - Interest rate & Currency.
Equity, Index, and Future's options - calls, puts and compounds
f. Hedging classes of investments
Classes of investments: capitalizations, sectors, currencies, geographic regions or countries, interest rates and commodities can all be hedged.
Hedging Market Capitalization risk:
S & P 500 Large Cap
S & P 400 Mid Cap
S & P 600 Small Cap
Hedging Industry Sector risk:
S & P Financial
S & P Healthcare
S & P Technology
S & P Cyclical
S & P Non-Cyyclical
Hedging Currency risk:
Hedging Geographic Region or Country risk:
Hedging Interest Rate risk:
Hedging Commodity risk :
a. Hedging risk