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  1. I don't understand the notion below of "enclosing" or "including" the 2nd bad debt into the 1st more secure debt. If you already owe the larger debt with larger security, then haven't you spawned a new separate bad debt that you're now trying to protect?

  2. How exactly did debtors enclose their second bad debt into their first debt?

I, not the source, boldened everything below. Google Answers: Origin of use of verb 'to hedge' as in 'hedge a bet'

Hedging a bet comes from the same linguistic roots as hedging a field. The idea of a hedge as a defence or enclosure making something secure is the starting point for the image of hedging bets. "Hedge" as a metaphor for making one's bet safer, by enclosing it within another [I boldened.], less risky bet dates back to the seventeenth century. "To secure oneself against loss (on a bet etc.) by betting etc. on the other side." This sense of "hedge" dates from 1672 according to the Oxford English Dictionary (OED).

hedge (v.) | Origin and meaning of hedge by Online Etymology Dictionary

late 14c., "make a hedge," also "surround with a barricade or palisade;" from hedge (n.). The intransitive sense of "dodge, evade, avoid committing oneself" is first recorded 1590s, on the notion of hiding as if in a hedge. That of "insure oneself against loss," as in a bet, by playing something on the other side is from 1670s, originally with in; probably from an earlier use of hedge in meaning "secure (a debt) by including it in a larger one which has better security" (1610s). Related: Hedged; hedging. The noun in the wagering sense is from 1736.

'Hedge your bets' - meaning and origin.

It began to be used in relation to financial transactions, in which a loan was secured by including it in a larger loan, in the early 17th century. Initially, the phrase associated with this form of hedging was 'hedging one's debts', for example, John Donne's Letters to Sir Henry Goodyere, circa 1620:

"You think that you have Hedged in that Debt by a greater, by your Letter in Verse."

Inky Fool: How John Donne Invented the Hedge Fund

That's the first recorded usage of the phrase hedge in meaning to secure a bad debt by making it part of a larger one for which better security has been obtained. Although this was the first common financial use of hedging.

From that sense of making your debts safe, came the idea of hedging in your bets by betting on more than one horse which pops up in 1672. From there you get the idea of finding two near-identical things at different prices, buying the cheaper and shorting the dearer. And thus the hedge fund.

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  • $\begingroup$ The provided text has just been copied around the various sources. Pretty clear it was not written by an accountant or lawyer. The only thing that appears to make sense is that the two loans share the same collateral, raising the quality. The other interpretation I see is that this is what we would call diversification- lowering the risk of the portfolio having a weighting of higher quality debt. (Diversification is not considered a hedge in modern usage.) $\endgroup$ – Brian Romanchuk Oct 1 '20 at 12:18
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(Please note that is guesswork based on the linked text.)

From the Inky Fool page:

Then, in the early seventeenth century John Donne promised a chap called Sir Henry Goodere that he would send him a letter in verse. He didn't get round to it, and to make matters worse Goodere wrote him one, which meant that Donne really owed him. Or, as Donne put it in an apologetic letter:

I owed you a Letter in verse before by mine own promise, and now that you think that you have hedged in that debt by a greater by your Letter in verse, I think it now most seasonable and fashionable for me to break.

John Donne already owed him a letter, then that obligation for a letter got rolled into a larger obligation.

This is obviously a non-financial obligation. To what extent we can extend this to finance, an existing debt is rolled into a larger new loan, with the new loan having better collateral than the old. In a modern context, it would be something like rolling a credit card debt into a home equity line.

(The only other interpretation I can think of - which does not fit this example - would be to reduce risk in a book of loans by diversification. I.e., replace riskier loans with ones secured by stronger collateral. This would not be considered “hedging” by modern portfolio managers, but it might match a loose interpretation of “hedge your bets.”)

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