Hedging in the financial futures market

A hedge is a countervailing investment made to protect an asset. Derivatives are frequently used in a defensive way by fund managers to protect investors from the downside of their investment. Hedge funds speculate quite aggressively, employing considerable leverage to maximize returns. They can commit up to 20 times the worth of their assets to the financial markets by the trading of derivatives such as futures contracts. An agreement is thereby made to buy or sell a fixed amount of a currency, bond or commodity at a fixed date. Only a small value of the face values needs to be put up as margin or collateral because the goods have not actually been traded when the derivative position is taken on. Concerns have been expressed about the excessive use of financial derivatives in that investors may be drawn into highly speculative investments whose risks they do not fully understand. Regulators are concerned that large institutional investors may find themselves out of their depth if the market falls heavily. In a falling market, a fund manager's liability could quickly outpace the assets of his fund entraining other stockbrokers working as counter-parties in the same deals. The consequent domino effect could lead to the collapse of the world banking system.