What is a Hedge Account?

Published by Thomas Herold in Accounting, Economics, Trading

'Hedge Account' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A hedge account is an account established with a hedge fund. There are several reasons why a person or business would be interested in setting up a hedge account. These mostly center on the desire for investments that commonly produce higher profits or the wish to hedge, or protect, a business’ operations from certain unpredictable and undesirable swings in market prices. Businesses can open up their own hedge accounts in various futures and commodities markets to protect themselves from these business impacting price movements in important related commodities.

A person who is interested in opening a hedge account will have to make application to a hedge fund. Hedge funds are typically restrictive in the types of funds that they will accept from an investor. The investor will have to prove certain income levels or asset base holdings that demonstrate that they are capable of bearing the substantial losses that could result from trades in a hedge account. They must also have liquid cash that they can tie up for long periods of time, since most hedge funds do not allow immediate on demand withdrawals.

Funds that are invested with them could be tied up for a year or longer, and minimum waiting periods apply. Because of all of these reasons, hedge funds are typically looking for people as investors who have in excess of a million dollars of liquid net worth.

Hedge accounts can also be accounts that businesses use to offset the changes in commodities’ prices. A company’s products may be heavily dependent on prices such as sugar and cocoa if they are a chocolate company, oil and other energy prices if they use energy intensive processes or are shipping companies, or even industrial metals such as copper if they produce wires or cables. Gold and silver mining companies, along with oil producers, routinely hedge their quantities of precious metals and energies that they expect to produce to protect against anticipated declining prices. By locking in the present price for these goods and commodities that they require or will produce later on in the year, they can insulate themselves from price swings that move against them.

This can mean the difference between having to raise prices and risk losing market share or selling goods at a much lower profit margin. Because of this, many major multinational companies around the world routinely protect themselves and their operations through the use of hedge accounts. Some of them even have individuals or departments that oversee these operations.

For a business to set up such a hedge account is not difficult. They only have to open a commodities account with one of the major commodities exchanges, such as the Chicago Mercantile Exchange, the Chicago Board of Trade, New York Mercantile Exchange, or the New York Board of Trade. These accounts can be used by companies for speculating on the price movements of underlying commodities as well, and not only for hedging their operations. In this case, care has to be taken, as the leverage provided by hedge accounts, such as commodities accounts, is enough to bring down a company overnight if they are irresponsible with the trades in the account.

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The term 'Hedge Account' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.