Chapitre 3 - Manuel

Question 1

When is short hedge appropriate ? (3)

Answer 1

• Hedger already owns an asset and expects to sell it at some time in the future
• Asset is not owned right now but will be owned in the future
• Offset risk of an existing long poosition

Question 2

When is the long hedges appropiate ?

Answer 2

When a company knws it will have to purchase a certain asset in the future and wants to lock in a profit

Question 3

Hedging and shareholders (5)

Answer 3

• Shareholders and do the hedging themselves
• Large transactions are less expensive when carried out by the company instead of share hlders
• Size of futures contracts makes hedging by individual shareholders impossible in many situations
• Shareholders can diversify risks more than corporation
• Sharholders with a well-diversified prtfli may be immune to risks face by corporoation

Question 4

If companies are acting in the best interst of well-diversified shareholders, hedging might be __

Answer 4

If companies are acting in the best interst of well-diversified shareholders, hedging might be unnecessary in many situatins

Question 5

A company that des not hedge can expect its prfit margin to be __

Answer 5

A company that des not hedge can expect its prfit margin to be constant

Question 6

A company that des not hedge can expect its profit margin to__

Answer 6

A company that des not hedge can expect its profit margin to be __

Question 7

What is the risk of hedging for treasures ?

Answer 7

• Can result in a decrease / increase in a company’s profit relative to its position without hedging
• Increase risks for treasurers if the others do not fully understand what is being down

Question 8

What is the only solutin for treasurers ?

Answer 8

Ensuring that all senirs executives fully understand the nature fo hedging before a hedging program is put in place

Question 9

3 problemes leading to basis risk

Answer 9

• Asset to be hedged not exactly the same as the asset underlying the futures contract
• Hedger may not be certain of the exact date the asset will be bought / sold
• Hedger may require futures contract to be closed out before its delivery month

Question 10

What leads to the basis change ?

Answer 10

Spot price and futures price d not necessarily change by the same aunt

Question 11

Suppose that a company plans to use a short hedge because it plans to sell the asset. What happens if :

A) Basis strenghtens

B) Basis weakens

Answer 11

A) Basis strenghtens : position improves because it will get a higher price for the asset ater future gains / losses are cnsidered

B) Basis weakens : position worsens because it will get a lwoer price for the asset after future gains / losses are considered

Question 12

Suppose that a company plans to use a long hedge because it plans to buy the asset. What happens if :

A) Basis strenghtens

B) Basis weakens

Answer 12

A) Basis strenghtens : position worsens because it will pay a higher price for the asset after future gains / losses are considered

B) Basis weakens : position imprvoes because it will pay a lower price fr the asset after future gains / losses are considered

Question 13

Which contract is chosen when the expiration of the hedge is a delivery month ?

Answer 13

Coontract with a later delivery month because futures prices are erratic during the delivery month

Question 14

What risk is the long hedger taking if the contract is held during the delivery month?

Answer 14

Runs the risk of having to take delivery of the physical asset (expensive and inconvenient)

Question 15

True or false: liquidity tends to be greater in long maturity futures contracts ?

Answer 15

False: liquidity tends to be greater in short maturity futures contracts

Question 16

Hedge ration : definition

Answer 16

Size of the position taken in futures contracts to the size of exposure

Question 17

What is the hedge ratio if the futures asset is the same as the hedged asset

Answer 17

Hedge ratio = 1.0

Question 18

Hedger should choose a value of hedge ratio that ___

Answer 18

Hedger should choose a value of hedge ratio that minimizes the variance of the value of the hedged position

Question 19

What deos the variance hedge ratio depends on ?

Answer 19

The relationship between changes in the spot price and changes in the futures price

Question 20

What does h* represent (2) ?

Answer 20

• slopoe of the best-fit line from a linear regression of ΔS and ΔF
• ratio of the average change ins S for a particular change in F

Question 21

Hedge effectiveness : definition

Answer 21

proportion of the variance that is eliminated by hedging (p²)

Question 22

A stock index tracks ___

Answer 22

A stock index tracks changes in the value of a hypothetical portfolio of stocks

Question 23

Why are dividends not included in the calculation of stock index ?

Answer 23

Index tracks capital gain/loss from investing in the portfolio

Question 24

True or false : the weights assigned to individuals stocks remain fixed

Answer 24

False : when the price of one particular stock in the portfolio rises more than others, more weight is automatically given to that stock

Question 25

Indices are constructed so that weights are ___

Answer 25

Indices are constructed so that weights are proprtional to market capitalization

Question 26

Portfolio adjusted automatically to reflect … (3)

Answer 26

• Stock splits
• Stock dividends
• New equity issues

Question 27

• 30 blue-chip stocks in the USA
• Weights proportional to their prices
• CME trades 2 futures contracts on the index (10$ * index, 5$ * index)
• Mini contracts trades mosot actively

Answer 27

Daw Jones Industrial Average (4)

Question 28

GUESS WHO ?

• 500 different stocks
• Weights proportional to market capitalization
• Large publicly held companies that trade on NYSE, Euronet or NASDAQ

Answer 28

S&P 500

Question 29

GUESS WHO

• 100 stocks
• CME trades 2 futures contracts on the index (100$*index, 20$*index)
• Mini contract trades most actively

Answer 29

NASDAQ - 100 (3)

Question 30

True or false: futures contracts on stock indices are settled in cash and all contracts are marked to market

Answer 30

True

Question 31

Beta of an asset : definition

Answer 31

Slop of the best-fit line when the return on the asset is regressed against the return of a well-diversified stock index

Question 32

What does a beta of 1 means ? What does a beta of 2 means ?

Answer 32

Beta = 1 : return on portfolio reflects the return on index

Beta = 2 : return on portfolio twice as great as the changes in the index

Question 33

h* vs Beta

Answer 33

h* : slope of the best-fit line when changes in the portfolio are regressed against the futures price of the index

B: slope of the best-fi t line when the return on the portfolio is regressed against the return from the index

Question 34

Reasons for hedging an equity portfolio and not invest in risk-free investments (4)

Answer 34

• Hedger feels the stocks in the portfolio has been chosen well (confident that the stocks in the portfolio will out perform the market)
• A hedge using index futures removes the risk arising from market moves (hedger only exposed to the performance of the portfolio relative to the market)
• Hedger is planning to hold a portfolio for a long period and requires short-term protection in an uncertain market situation
• Alternative strategy of selling the portfolio and buying it back later = high transaction costs

Question 35

What position is required if B > B* (decrease the beta)

Answer 35

Short position

Question 36

What position is required if B < B* (increase the beta)

Answer 36

Long position

Question 37

What does the hedger have to do if the expiration date of the hedge is later thanthe delivery date of all the contracts available ?

Answer 37

Roll the hedge forward by closing out one futures contract and taking position in a futures contract with a laeter delivery date

Question 38

Does a perfect hedge always lead to a better outcome?

Answer 38

No, completely neutralizes the gains whereas an imperfect hedge only partially neutralizes the gains

Question 39

Under what circumstances does a minimum variance hedge portfolio lead to no hedging at all?

Answer 39

When the coefficient of correlation between changes in the futures price and changes in the price of the asset being hedged = 0

Question 40

Give three reasons why the treasurer of a company might not hedge the company’s exposure to a particular risk.

Answer 40

• If competitors d not hedge, the treasurer might feel the company will experience less risk if it does not hedge either
• Shareholders might not want the company to hedge
• Hard to explain to executives if gains from exposure to underlying asset and loss on the hedge

Question 41

What does a 0.64 hedge ratio means ?

Answer 41

• The company should hedge 64% of its exposure
• The size of the future sposition should be 64% the size of the company’s exposure in a hedge

Question 42

Does a perfect hedge always succeed in locking in the current spot price of an asset for a future transaction? Explain your answer.

Answer 42

No : forward contracts locks in the forward exchange rate but it is different from the spot exchange rate

Question 43

‘‘If the minimum variance hedge ratio is calculated as 1.0, the hedge must be perfect.’’ Is this statement true? Explain your answer.

Answer 43

No, because the coefficient of correlation is lower than 1

Question 44

‘‘If there is no basis risk, the minimum variance hedge ratio is always 1.0.’’ Is this statement true? Explain your answer.

Answer 44

True

The hedger locks in a price f₁ + b₂ when the hedge ratio is 1.0 (since both f ₁and b₂ are known, this has a variance of zero and must be the best hedge)