Chapitre 3 - Manuel Flashcards by Jimmy Chau

When is short hedge appropriate ? (3)

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

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When is the long hedges appropiate ?

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

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Hedging and shareholders (5)

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

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

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

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

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

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

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

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What is the risk of hedging for treasures ?

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

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What is the only solutin for treasurers ?

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

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3 problemes leading to basis risk

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

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What leads to the basis change ?

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

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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

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

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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

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

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

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

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

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

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

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

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Hedge ration : definition

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

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

Hedge ratio = 1.0

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Hedger should choose a value of hedge ratio that ___

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

What deos the variance hedge ratio depends on ?

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

What does h* represent (2) ?

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

Hedge effectiveness : definition

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

A stock index tracks ___

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

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

Index tracks capital gain/loss from investing in the portfolio

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

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

Indices are constructed so that weights are \_\_\_

Indices are constructed so that weights are **proprtional to market capitalization**

Portfolio adjusted automatically to reflect ... (3)

* Stock splits * Stock dividends * New equity issues

* 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

Daw Jones Industrial Average (4)

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

S&P 500

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

NASDAQ - 100 (3)

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

True

Beta of an asset : definition

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

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

Beta = 1 : return on portfolio reflects the return on index Beta = 2 : return on portfolio twice as great as the changes in the index

h\* vs Beta

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

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

* 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

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

Short position

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

Long position

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

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

Does a perfect hedge always lead to a better outcome?

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

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

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

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

* 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

What does a 0.64 hedge ratio means ?

* 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

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

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

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

No, because the coefficient of correlation is lower than 1

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

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)