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Perfect Hedge

Perfect Hedge

Definition

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.

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