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Another solution

Posted By: Tom Keith
Date: Sunday, 16 October 2011, at 2:06 p.m.

In Response To: Hedging Controversy (Daniel Murphy)

"Because the winner gets $1500" -- what does that mean?

That's the crux of the misunderstanding.

What A thought he meant: "The winner gets a prize worth $1500 (entry to the tournament)."

What B thought A meant: "The winner gets $1500 cash."

If B was planning to enter the tournament anyway, then it doesn't make much difference. He can pay A out of the money he doesn't have to spend on the entry fee. But presumably B was only going to enter the tournament if he won the qualifier. So B finds himself in a position of perhaps having to pay A and win nothing himself, which doesn't seem right.

That suggests another possible solution. B could sell his entry in the tournament to A, and then pay the hedge bet out of that. If that's agreeable to A, then B gets exactly what he thought he would get.

But maybe A doesn't want to pay the full $1500. In that case, here is what they could do:

1. A and B bid on what they think the value of entry to the tournament is. (E.g., A offers $700. B thinks its worth more and offers $800, etc.)

2. If A wins the bidding, then A pays B that amount and B gives A his entry to the tournament. If B wins the bidding, B keeps his entry to the tournament, but accepts that he has now won a prize worth that amount.

3. Then B pays off the hedge bet. But B pays only a fraction of the full hedge bet, because it turns out that the value of entry to the tournament is less than $1500.

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