9 - Hedging with Futures Flashcards Preview

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Flashcards in 9 - Hedging with Futures Deck (26)
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1
Q

why do investors hedge?

A

to reduce risk or alter risk exposure

  • ie control import/export prices, tax potential, smooth earnings
2
Q

why is hedging not always a good idea?

A
  • can give misleading impression of risk reduction
  • hedging eliminates the opportunity to take advantage of favourable markets
  • hedging is just speculation
3
Q

what does a short hedge imply?

A

you take up a short position in futures contracts

usually done when you own the spot price

4
Q

what does a long hedge imply?

A

you take up a long position in futures contracts

usually done when you have short sold the spot price

5
Q

what is basis risk?

A

the difference between the spot price and the futures price

basis= spot - futures

6
Q

what is the profit formula for a short hedge? for a long hedge?

what if held to expiry?

A

cap pi = (St-So) - (ft-fo)
cap pi = -(St-So) + (ft-fo)

note this is if position is closed before expiry
cap pi = (St) - (ft)
cap pi = -(St) + (ft)

because prices merge at expiry

7
Q

what’s the basis at expiration?

A

0

8
Q

whats the basis risk at time 0?

A

bo= So - fo

9
Q

whats the basis risk at any time during between 0 and expiry?

A

bt= St - ft

10
Q

what are two problems/risks with hedging?

A
  • spot and futures occasionally move in opposite directions - need them to move in tandem for the hedge to be successful.
  • quality risk
11
Q

what determines contract choice (which commodity to choose)?

A
  • cross hedging
  • which is most correlated with the spot
  • pricing of contract
  • margin requirements (low margins are desired, but must have enough cash to pay margin calls)
12
Q

what is a hedge ratio?

A

the number of futures contracts to hedge a particular exposure

13
Q

what is the minimal variance ratio?

A

the optimal varian minimising ratio

tis it the beta from a regression of spot price change on future price change

14
Q

how is the effectiveness of a hedge ratio determined?

A

e= (risk of unhedged position - risk of hedged position) / risk of unhedged position

it the r squared - how well is your independent variable explained by your dependent variable

15
Q

what are tailing the market hedge, stock index futures hedge, stock portfolio hedge, anticipatory hedge for a takeover, speculating on unsystematic risk, stock market timing with futures, stock index arbitrage all examples of?

A

stock index futures hedges

16
Q

what is the important adjustment that must be made for tailing the market hedge? when do you maintain/kill the hedge?

A

must account for the effect of interest on marking to market.

maintain hedge when interest decreases
kill hedge when interest high enough to cover transaction costs

17
Q

stock index futures hedge just accounts for which factor? what does it do?

A

the contract multiplier

one to one hedge

18
Q

what does anticipatory hedge for a takeover aim to do?

A

hedge against stock price increasing

19
Q

when you are trying to protect against stock price increasing, should you buy or sell futures contracts?

A

ALWAYS buy - even if the formula gives you a negative sign,

because if stock increases so will futures price, meaning when you buy futures back at a higher price you make a loss reducing the over all stock increase

20
Q

when hedging for speculating on unsystematic risk, what is the hedge designed to do?

A

eliminate systematic risk so as to capture unsystematic return of a stock that is believed to be underpriced
ie hedge against market fluctuations

21
Q

if you are expecting the prices to drop and you want to hedge against the drop what should you do with the futures contracts?

A

sell initially - more gain

buy later- at a lower price

22
Q

if you are expecting the prices to increase and you want to hedge against the increase what should you do with the futures contracts?

A

buy initially - costs more

sell later - receive less money

23
Q

to reach a target beta on a portfolio of stock how does the Nf = Beta (S/f) formula change?

A

Nf = B target - B current (S / f )

24
Q

when is the market in contango? are there arbitrage possibilities?

A

when the futures price > spot price

sell futures buy spot

25
Q

when is the market in backwardation? are there arbitrage possibilities?

A

when the futures price < spot price

buy futures sell spot

26
Q

what does index arbitrage involve?

A

simultaneous trades in futures and many different stocks