Chapter 3:Hedging Strategies using Futures

Question 1

What is the aim of hedgers?

Answer 1

Their aim is to use futures markets to reduce a particular risk that they face.

Question 2

Define: perfect hedge

Answer 2

It is one that completely eliminates the risk.

Question 3

When will you use a short hedge?

Answer 3

A short hedge is used when you plan to sell an asset in the future. There are 2 such scenarios:

- you already own the asset
- you don't own the asset yet but will own it some time in the future

Question 4

Formula for basis

Answer 4

Basis=spot price of asset to be hedged - futures price of contract used

Basis=futures price - spot price
^sometimes used when the futures contract is on a financial asset.

Question 5

What happens to the basis when the asset to be hedged and the asset underlying the futures contract are the same?

Answer 5

The basis should be zero at the expiration of the futures contract. Prior to expiration, the basis may be positive or negative.