Hedging

The following question and answer by Sheikh Yusuf Talal DeLorenzo attendees of the Dow Jones University Courses on Islamic Investement.Question:: Why is hedging haram?Answer: As a method for protecting a profit position from risk, it is easy to understand why hedging is popular. In conventional finance, risk-hedging takes the form of derivatives,swaps, futures, options, and other risk-shifting devices. The common perception of hedging in Islamic law is that it interferes with one of the law's basic principles, which is that gain accompanies liability for loss, or the link between risk to gain. Moreover, derivatives often contain elements of gharar (discussed in Lesson Two) which clearly render them unacceptable in an Islamic legal framework for the reason that they lead to undue speculation, which is the practical equivalent of gambling. Even so, hedging, in the sense of risk management, is not prohibited outright because the management of risk may take many forms, from portfolio diversification to leveraging equity capital throughIslamically-acceptable leases.

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