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D. M. Chance An Introduction to Derivatives and Risk Management, 6th ed. Chapter 9: Futures Hedging Strategies It is often said in the derivatives business that “you cannot hedge history.” Dan Goldman Risk Management for the Investment Community, 1999, p. 16 Important Concepts in Chapter 10 Why firms hedge Hedging concepts Factors involved when constructing a hedge Hedge ratios Examples of foreign currency hedges, intermediate- and long-term interest rate hedges, and stock index futures hedges Why Hedge? The value of the firm may not be independent of financial decisions because Shareholders might be unaware of the firm’s risks. Shareholders might not be able to identify the correct number of futures contracts necessary to hedge. Shareholders might have higher transaction costs of hedging than the firm. There may be tax advantages to a firm hedging. Hedging reduces bankruptcy costs. Managers may be reducing their own risk. Hedging may send a positive signal to creditors. Dealers hedge their market-making activities in derivatives. Why Hedge? (continued) Reasons not to hedge Hedging can give a misleading impression of the amount of risk reduced Hedging eliminates the opportunity to take advantage of favorable market conditions There is no such thing as a hedge. Any hedge is an act of taking a position that an adverse market movement will occur. This, itself, is a form of speculation. Hedging Concepts Short Hedge and Long Hedge Short (long) hedge implies a short (long) position in futures Short hedges can occur because the hedger owns an asset and plans to sell it later. Long hedges can occur because the hedger plans to purchase an asset later. An anticipatory hedge is a hedge of a transaction that is expected to occur in the future. See Table 10.1, p. 348 for hedging situations. Hedging Concepts (continued) The Basis Basis = spot price - futures price. Hedging and the Basis P (short hedge) = ST - S0 (from spot market) - (fT - f0) (from futures market