11-08-2012, 03:32 PM
Hedging Using Futures
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Long hedge
• Take a long position in the futures market.
• Appropriate for someone who expects to buy an asset and wants
to guarantee the price.
Basis and basis risk
• Perfect hedge does not always exist
The asset we are trying to hedge may not be exactly the same as
the asset underlying the futures.
– The time at which we sell the asset (which could be random)
might not be exactly be the same as the delivery date of the
futures.
Basis risk
– If bT were known at t0, we would have a perfect hedge (because if bT
is known, then bT is fixed. This means that ST and FT must always
change by equal amounts, leaving income unchanged).
– When bT is unknown at time t0, the uncertainty about the period T
income, captured by the uncertainty about the value of bT , hence
called basis risk.
Minimum variance hedge ratio
• Hedge ratio
– The size of the position in futures contracts relative to the
exposure (i.e., the value of the asset being hedged).
– More simply, the number of units of asset in futures contracts per
unit of asset being hedged.
Denis