Hedging long and short l.jpg
This presentation is the property of its rightful owner.
Sponsored Links
1 / 11

Hedging: Long and Short PowerPoint PPT Presentation


  • 162 Views
  • Updated On :
  • Presentation posted in: General

Hedging: Long and Short. Long futures hedge appropriate when you will purchase an asset in the future and fear a rise in prices If you have liabilities now, what do you fear? Short futures hedge appropriate when you will sell an asset in the future and fear a fall in price

Download Presentation

Hedging: Long and Short

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Hedging long and short l.jpg

Hedging: Long and Short

  • Long futures hedge appropriate when you will purchase an asset in the future and fear a rise in prices

    • If you have liabilities now, what do you fear?

  • Short futures hedge appropriate when you will sell an asset in the future and fear a fall in price

    • If you expect to issue liabilities, what do you fear?


Arguments for hedging l.jpg

Arguments For Hedging

  • Companies should focus on their main business and minimize risks arising from interest rates, exchange rates, and other market variables

    • Non-intrusive risk management tool

  • Hedging may help smooth income and minimize tax liabilities

  • Hedging may help smooth income and reduce managerial salaries


Arguments against hedging l.jpg

Arguments Against Hedging

  • Well-diversified shareholders can make their own risk management decisions

  • It may increase business risk to hedge when competitors do not

  • Explaining a loss on the hedge and a gain on the underlying can be difficult


Basis risk l.jpg

Basis Risk

  • Basis is the difference between spot and futures prices

  • Basis risk arises because of uncertainty about the price difference when the hedge is closed out

  • Basis risk usually less than the risk of price or rate level changes

  • Basis risk depends on futures pricing forces


Choice of hedging contract l.jpg

Choice of Hedging Contract

  • Delivery month should be as close as possible to, but later than, the end of the life of the hedge

  • If no futures contract hedged position, choose the contract whose futures price is most highly correlated with the asset price

    • Called cross-hedging

    • Additional basis risk


Naive hedge ratio l.jpg

Naive Hedge Ratio

  • Divide the face value of the cash position by the face value of one futures contract

  • Problems:

    • Market values should be focus

    • Ignores differences between the cash and futures instruments

  • Variation: divide the market value of the cash position by the market value of one futures contract


Minimum variance hedge ratio l.jpg

Minimum Variance Hedge Ratio

  • Proportion of the exposure that should optimally be hedged is

    hedge per dollar of cash market value

  • Hedge ratio estimated from:


Hedging stock portfolios l.jpg

Hedging Stock Portfolios

  • If hedging a well-diversified stock portfolio with a well-diversified stock index futures contract, what are implications?

    • No diversifiable risk in the cash stock portfolio and futures hedge removes systematic risk

    • Since no risk, systematic or unsystematic, what can an investor expect to earn by hedging a well-diversified stock portfolio?


Hedging stock portfolios9 l.jpg

Hedging Stock Portfolios

  • But has all risk been eliminated?

  • Problems:

    • Stock portfolio being hedged may have a different price volatility than the stock-index futures

    • Hedging goal is not to reduce all systematic risk

  • Price sensitivity to market movements determined by beta


Hedging stock portfolios10 l.jpg

Hedging Stock Portfolios

  • Optimal number of contracts to hedge a portfolio is

  • Future contracts can be used to change the beta of a portfolio

    • If b* >(<) bS, hedging implies a long (short) stock index futures position


Rolling the hedge forward l.jpg

Rolling The Hedge Forward

  • What if hedging further in the future than available delivery dates?

  • Series of futures contracts used to increase the life of a hedge

  • Each time a futures contract matures, switch position into another, later contract

    • Basis risk, cash flow problems possible


  • Login