on the owner's assets. The typical intent of the hedger, however, usually is not to enter into a series of transactions which will insure that no impact on the hedger's assets occur. Rather, the usual intent a hedger is to limit the extent of any risk, while still preserving the potential for gain, through the set of transactions. The hedger, by limiting risk, purposefully limits the potential of any gain; however, most have no desire to create a no impact situation.
Hedging is most commonly used by producers and traders in commodities, as a means of limiting risk in the face of significant uncertainty, although speculators also make use of the concept of hedging. When speculators use hedging procedures, they are, in effect, creating risk where none previously existed. Thus, speculators are more gamblers than they are hedgers. Hedgers, if they are speculators, are betting that prices on items will change over time, while hedgers, if they are producers or traders, are protecting themselves, in the event that prices on items do change. The difference between the two types of hedgers is subtle but significant.
Hedging is also applied to financial transactions such as trading in foreign currencies. If a holder of financial assets and liabilities has reason to fear that prices may change in such a way that the value of the financial vehicles will be adversely affected, hedging may be used to limit risk. When holders of financial instruments simply play the market, engaging in long and short selling in the puts and calls options market, they are simply speculators who are creating risk where none previously existed (Brealey and Myers, 1991, pp. 458 459). When such holders use hedging as a tool to limit risk, however, they are hedgers.Where hedging is used by producers, traders, and speculators as either a protection against or as a means of exploiting future price changes, arbitrage is used by either the owners of item...