Topic 26 - Hedging Strategies Using Futures

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CONFIDENTIAL

April 24, 2012

GAMMA FRM-I

Topic 26 - Hedging Strategies using Futures


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AIM 26.1

AIM 26.1 Define and differentiate between shortand long hedges and identify appropriate uses.
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Short Hedge & Long Hedge -P 19 21, NCFM Equity Derivative

( to be discussed in session )

< Kaplan explained in too concise form >


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The next few slides talk about Long Hedge andShort Hedge taken from Core Material, Hull


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Who can be nominated / enroll ? the associates of various accounts ofBFS3 and other IB-related groups whom theGL nominates for the competency development in Derivatives

those associates who have already certifications in Derivatives ( e.g NCFM ) or havereal interest in this area and are interested to know a bit more deeply from finance pointof view and aspiring forDerivatives-based techno-functional / functional role / SME those who are targeting forRisk Management roles and planning forFRM exam, CFAexam those who were interested to go thru the Hull bookto increase their competencylevel but could not find time to do so

What is the Program Methodology ? Instructor-led-training thru webex / Video-Conf. to associates of BFS3 spreadacross various locations White-board facility of webex will be used to make the associates understand the

conceptual parts Though webex based, yet the sessions will be interactive and in participatory mode e.gknowledge sharing, questioning to faculty and participants, tutorials discussion Faculty - Subrato Das ( Exe. MBA ( Finance ), IIM Calcutta; Domain Consultant,Capital Market & FS Solutions BFS3 ISU; had worked in Derivatives-based project intechno-functional role in Morgan Stanley a/c )


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Salient Features






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AIM 26.2AIM 26.2 Describe the arguments for and against hedgingand the potential impact of hedging on firm profitability.

- not an imp. AIM- can go thru Kaplan, AIM 26.2


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AIM 26.3 & 26.4

AIM 26.3 & AIM 26.4 Define the basis and thevarious sources of basis risk, and explain how basis

risks arise when hedging with futures.


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Salient Features






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Salient Features






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Net selling price in case of short hedgeandNet buying price in case of long hedge

To be explained in session


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Salient Features






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S


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>


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AIM 26.5 & 26.6

AIM 26.5 & AIM 26.6 Define cross hedging, andcompute and interpret the minimum variance hedge

ratio and hedge effectiveness

S li t F t


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Salient Features





S li t F t


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Salient Features





H d ti t


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Hedge ratio .. cont.

S li t F t


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Salient Features





Salient Features


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AIM 26 7


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AIM 26.7

AIM 26.7 Define, compute, and interpret theoptimal number of futures contracts needed to

hedge an exposure, including a tailing the hedgeadjustment.


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Tailing the Hedge


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Tailing the Hedge

When futures are used for hedging, a small adjustment, known

as tailing the hedge can be made to allow the impact of dailysettlement.

Thus, optimal no. of futures contracts N* = h* VA / VF where

VA is the dollar value of position being hedged and VF is

the dollar value of 1 future contract ( the futures price times QF )

Suppose in Example 3.3, the spot and futures price are 1.94and 1.99 dollars per gallon, then VA = 2,000,000 x 1.94 =

3,880,000 while VF = 42,000 x 1.99 = 83,580, so optimal no.

of contracts = 0.78 x 3,880,000 / 83,550 = 36.22 = 36

rather than 37

AIM 26 8


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AIM 26.8

AIM 26.8 Demonstrate how to use stock indexfutures contracts to change a stock portfolios beta.

Very Imp. Topic

Pl. go thru sec. 3.5 Stock Index futures of Hull

( Hedging an Equity Portfolio, Changing the Beta

of Portfolio )

Shall have Q&A / discussion on this in next

session


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Some Q&A solving would be taken up in

next sessions

AIM 26 9


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AIM 26.9

AIM 26.9 Describe what is meant by rolling thehedge forward and discuss some of the risks that

arise from such a strategy.

Salient Features


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Salient Features



What is the Program Methodology ? Instructor-led-training thru webex / Video-Conf. to associates of BFS3 spreadacross various locations White-board facility of webex will be used to make the associates understand theconceptual parts Though webex based, yet the sessions will be interactive and in participatory mode e.gknowledge sharing, questioning to faculty and participants, tutorials discussion Faculty - Subrato Das ( Exe. MBA ( Finance ), IIM Calcutta; Domain Consultant,Capital Market & FS Solutions BFS3 ISU; had worked in Derivatives-based project intechno-functional role in Morgan Stanley a/c )

Salient Features


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Rolling the hedge forward contd.


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In the above example, the oil price declined from $19 to $16. Had we

not hedged, a loss of $3. Bcos of hedging, we could limit the loss to

$3 - $1.7 = $1.3

Salient Features


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Topic 26 - Hedging Strategies Using Futures

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