Lecture 7 Hedging with Futures. Primary Texts Edwards and Ma: Chapters 5 & 6 CME: Chapter 5. Hedging Fundamentals. Hedging: The activity of trading futures with the objective of reducing or controlling price risk (due to uncertainty about future price levels) is called hedging.
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Edwards and Ma: Chapters 5 & 6
CME: Chapter 5
Short Hedge (with Basis Risk)Basis Shrinks
Change in Basis = Long Basis – Short Basis
exposure to basis risk
deviate from the mean (cash price)
= Var(CP − FP)
= Var(CP) + Var(FP) – 2Cov(CP , FP)
Qc = the quantity of the cash commodity that is being hedged.
Qf = the size (quantity) of the futures position = NFC×Qfc
Qfc = the size of the futures contract
NFC = Number of futures contracts
∆VH = ∆CP× Qc − ∆FP× Qf
Qfc= the size of the futures contract
Estimating the Hedge Ratio