Hedging myths VI - "Derivatives are dangerous. They're for speculators, not for us."

Hephaestus was the Greek god of the forge. (Hence we at Forge aHedge have a special fondness for him). He crafted Achilles' shield, Hermes' winged helmet and Aphrodite’s girdle. The same fire and the same anvil that armed the gods created works of jewellery and elegant thrones. The tool was never the danger. What mattered was what it yielded, and to what purpose.

Derivatives carry the same poor reputation. Say "derivatives" in a boardroom and someone will probably mention Enron, or a rogue trader, or the GFC. The instrument gets blamed for those who misuse it.

But a forward contract that locks in the price of your copper purchases isn't a bet; it's the removal of one. A swap that fixes your fuel cost isn't gambling; it's really the opposite. Speculation is taking a position on a price you have no underlying exposure to. Hedging is neutralising a price risk your business already carries.

The company that refuses to hedge because "derivatives are speculation" hasn't avoided taking a view on prices. It's actually taken the biggest speculative position of all: fully exposed to market volatility.

The forge doesn't decide what gets made. You do. Managed properly, by matching real exposures, dealing with controls and correctly accounting, derivatives are amongst the best financial risk-removal tools ever created.

Next up - "Our treasurer has it covered" – can you guess who this is? See here.