Question

Differences between hedging and insurance for 10marks

Answer 1

the difference between hedging and insurance is as follows

The concept of hedging is to transferring the risk to the speculator through purchase of future contracts .An insurance contract, however, is not the same thing as hedging .Although both technique are similar in that risk is transferred by a contract, and no new risk is created, there are some important difference between them.

First, an insurance transaction involves the transfer of insurable risks, because the requirement of an insurable risk generally can be met .However, hedging is a technique for handling risks that are typically uninsurable ,such as protection against a decline in the price agriculture products and raw materials.

A second difference between insurance and hedging is that insurance and hedging is that insurance can reduce the objective risk of an insurer by application of the law of large numbers. As the number of exposure units increases, the insurer’s prediction of future losses improves, because the relative variation of actual loss from expected loss will decline .thus, many insurance transactions reduce objective risk.

In contract, hedging typically involves only risk transfer , not risk reduction .The risk of adverse price fluctuation is transferred because of superior knowledge of market conditions .The risk is transferred, not reduced, and prediction of loss generally is not based on the law of large numbers

Answer 2

Answer:

First, an insurance transaction entails transferring insurable risks because an insurable risk may often be fulfilled. Hedging, on the other hand, is a strategy for managing normally uninsurable risks, such as defence against a fall in the price of agricultural goods and raw resources.

Explanation:

The difference between hedging and insurance is as follows

Hedging is the idea of shifting risk to the speculator by buying future contracts. Hedging, however, is not the same as an insurance arrangement. There are several significant differences between the two strategies, even though they are identical in that risk is transferred through a contract, and no new risk is produced.

A second distinction between insurance and hedging is that, via the use of the rule of large numbers, insurance may lower the objective risk of an insurer. The insurer's ability to estimate future losses improves as the number of exposure units rises because the relative difference between actual and predicted losses decreases. As a result, many insurance transactions lower actual risk.

Hedging, on the other hand, usually simply entails risk transfer, not risk reduction. Due to a greater understanding of market circumstances, the risk of unfavourable price volatility is shifted. The risk is transferred rather than diminished. Therefore the rule of big numbers is typically not used to anticipate losses.

Insurance premiums and the cost of the options in the event of a hedging strategy are both financial outlays. However, these expenses are smaller than the losses you are avoiding. Because of this, the cost is justified.