Hedging Strategies Using Futures.pptVIP

GSBS6142 Derivatives Risk Management 3.* Hedging Strategies Using Futures Aim of this Chapter Arguments for and against Hedging Basis risk and hedging strategies Definition of basis risk Short and Long hedge Cross hedging Optimal hedging ratio Stock index futures Changing Beta 3.* Long Short Hedges A long futures hedge is appropriate when you know you will purchase an asset in the future and want to lock in the price A short futures hedge is appropriate when you know you will sell an asset in the future want to lock in the price Some things about Hedging Hedging decreases risk but sometimes decreases profits Leads to treasurers feeling reluctant to hedge Ensuring that all senior executives fully acknowledge the hedging procedure How will gold mining companies hedge their risk of from dropping gold prices? Enter a short futures or forward contract If the counter party is a financial institution how will the institution hedge their risk? Question A bakery needs 50,000 bushels of wheat in May A wheat futures contracts on CboT for May is currently $3.25 per bushel Each contract is worth 5000 bushels What is your strategy? Question continued What happens if the nearest delivery date is not may but June? /trading/agricultural/grain-and-oilseed/wheat.html Would there be any way to use the spot and futures price on May? Try closing out the position and delivering the spot Example - short Oil producer with a contract to deliver 1 mil. Barrel after three month Spot: $19 pb, futures price: $18.75 pb Short at 18.75 and close after 3 month If spot is 17.5 after 3 month? $17.5 from sell and $1.25 from futures If spot is 19.5 after 3 month? $19.5 from sell and -$0.75 from futures 3.* Basis Risk Basis is the difference between spot futures Basis risk arises because of the uncertainty about the basis when the hedge is closed out 3.* Basis Risk(Hedge initiated at time t1 and closed out at time t2) Time Spot Price Futures Price t1 t2 3.* Long Hedge Suppose that F1 : In