perfect hedge
An investment vehicle designed to mitigate the financial risk inherent in
a portfolio of investments and/or in the normal course of business. Financial
risk hedges are usually derivatives designed to counteract the price risk associated
with normal business activities, such as the purchase of raw materials. Derivative
hedges, however, are usually not perfectly correlated with the risk against
which they are supposed to hedge; thus, a degree of risk remains. A perfect hedge,
however, correlates perfectly with the risk. When insurance contracts are used
to hedge these risks, a perfect hedge is possible due to the fact that insurance
is a zero-sum transaction—that is, the contract either pays off or does not pay
off based on the policy claims trigger.