Question

How hedging affects risk and return. differentiate between routine hedging and hedging selectively

Answer 1

Hedging is a risk management approach that helps reduce the risk in a position (investment) by taking up a diagonally opposite position so that either way the capital is largely protected with limited downside potential. However since the hedging involves taking up an additional opposite position it involves costs which reduces returns considerably over the long run.

In selective hedging, we are trying to attempt hedging of a portion of the portfolio which we feel is risky (uncertain) whereas the rest of the portfolio s unhedged (unlike routine hedging). Else it may also involve selectively hedging at certain timepoints (when the risk is perceived to be high) and not always (unlike routine hedging). So by definition, routine hedging comes at a higher cost since you hedge always and everything but at a lower risk and vice versa for selective hedging.