Hedging Strategies Using Futures Flashcards
define
short hedge
Hedging Strategies Using Futures
a hedge that involves a short position in futures contracts
define
Hedging Strategies Using Futures
describe
when is a short hedge strategy appropriate?
Hedging Strategies Using Futures
if the hedger already owns an asset and expects to sell it at some time in the future; or,
if the hedger doesn’t own an asset, but expects to own it in the future
describe
Hedging Strategies Using Futures
define
long hedge
Hedging Strategies Using Futures
involves taking a long position in a futures contract
define
Hedging Strategies Using Futures
describe
when is a long hedge appropriate?
Hedging Strategies Using Futures
if the hedger knows it will have to purchase a certain asset in the future and wants to lock in a price now
describe
Hedging Strategies Using Futures
Describe
arguments in favor of hedging
Hedging Strategies Using Futures
- Firms not in finance have no particular skills or expertise in predicting variables such as interest rates
- Experts can even be wrong about their predictions
Hedging Strategies Using Futures
List reasons why
hedging is often not that straightforward
Hedging Strategies Using Futures
- The asset whose price is being hedged may not be the same as the underlying asset in the futures contract
- Uncertainty as to the exact of the disposal of the asset to hedged
- May require the futures contract to be closed out before the delivery month
Hedging Strategies Using Futures
Consequence of:
The asset whose price is being hedged may not be the same as the underlying asset in the futures contract
Hedging Strategies Using Futures
basis risk
Hedging Strategies Using Futures
Consequence of:
Uncertainty as to the exact of the disposal of the asset to hedged
Hedging Strategies Using Futures
basis risk
Hedging Strategies Using Futures
Consequence of:
May require the futures contract to be closed out before the delivery month
Hedging Strategies Using Futures
basis risk
Hedging Strategies Using Futures
Explain
cross hedging
Hedging Strategies Using Futures
occurs when the two assets are different. jet fuel futures are not actively traded, it might choose to use heating oil futures contracts to hedge its exposure
Hedging Strategies Using Futures
Formula
minimum variance hedge ratio
Hedging Strategies Using Futures
standard deviation of ΔS / standard deviation of ΔF
Hedging Strategies Using Futures
optimal number of contracts
calculate the number of contracts that should be used in hedging, define:
Hedging Strategies Using Futures
Qa: size of position being hedged (units)
Qf: size of one futures contract (units)
N*: optimal number of futures contracts for hedging
Hedging Strategies Using Futures
minimum variance hedge ratio
An airline expects to purchase 2 million gal. jet fuel in 1 mo. and decidies to use heating oil futures for hedging. Assume the standard deviation of the jet fuel price is 0.0313, the standard deviation of the heating oil price is 0.0263 and the correlation is 0.928.
Hedging Strategies Using Futures
0.928*(0.0263 / 0.0313) = 0.78
Hedging Strategies Using Futures
Explain
perfect hedge
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Explain
Does a perfect hedge always lead to a better outcome than an imperfect hedge
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Under what circumstances
minimum variance hedge portfolio lead to no hedging at all
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Explain
does a perfect hedge always succeed in locking in the current spot price of an asset for a future transaction?
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Explain
Is the hedge perfect if the minimum variance hedge ratio is 1.0?
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Explain
If there is no basis risk, is the minimum variance hedge ratio always 1.0?
Hedging Strategies Using Futures
Hedging Strategies Using Futures
True or False
When the futures price of an asset is less than the spot price, long hedges are likely to be particularly attractive?
Hedging Strategies Using Futures
Hedging Strategies Using Futures
What strategy should the beef producer follow?
The standard deviation of monthly changes in the spot price of live cattle is (in cents per pound) 1.2. The standard deviation of monthly changes in the futures price of live cattle for the closest contract is 1.4. The correlation between the futures price changes and the spot price changes is 0.7. It is now October 15. A beef producer is committed to purchasing 200,000 pounds of live cattle on November 15. The producer wants to use the December live cattle futures contracts to hedge its risk. Each contract is for 40,000 pounds of cattle.
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Calculate
The expected return on the S&P 500 is 12% and the risk-free rate is 5%. What is the expected return on an investment with a beta of (a) 0.2, (b) 0.5, and (c) 1.4?
Hedging Strategies Using Futures
Hedging Strategies Using Futures
What is the minimum variance hedge ratio?
A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is $28 and the standard deviation of the change in this price over the life of the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation between the spot price change and futures price change is 0.95.
Hedging Strategies Using Futures
Hedging Strategies Using Futures
Should the hedger take a long or short futures position?
A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is $28 and the standard deviation of the change in this price over the life of the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation between the spot price change and futures price change is 0.95.
Hedging Strategies Using Futures
Hedging Strategies Using Futures
What is the optimal number of futures contracts (no settlment adjusting)
A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is $28 and the standard deviation of the change in this price over the life of the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation between the spot price change and futures price change is 0.95.
Hedging Strategies Using Futures
Hedging Strategies Using Futures
How can the daily settlement of futures contracts be taken into account?
A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is $28 and the standard deviation of the change in this price over the life of the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation between the spot price change and futures price change is 0.95.
Hedging Strategies Using Futures
Hedging Strategies Using Futures
