This chapter presents the following content: To identify the commonly used techniques for hedging transaction exposure; to show how each technique can be used to hedge future payables and receivables; to compare the pros and cons of the different hedging techniques; and to suggest other methods of reducing exchange rate risk. | 3. Hedging Strategies Using Futures Lecture #16 3. Changing Beta What position is necessary to reduce the beta of the portfolio to What position is necessary to increase the beta of the portfolio to 3. 3. Hedging Price of an Individual Stock Similar to hedging a portfolio Does not work as well because only the systematic risk is hedged The unsystematic risk that is unique to the stock is not hedged 3. 3. Why Hedge Equity Returns May want to be out of the market for a while. Hedging avoids the costs of selling and repurchasing the portfolio Suppose stocks in your portfolio have an average beta of , but you feel they have been chosen well and will outperform the market in both good and bad times. Hedging ensures that the return you earn is the risk-free return plus the excess return of your portfolio over the market. 3. Rolling The Hedge Forward (page 67-68) We can use a series of futures contracts to increase the life of a hedge Each time we switch from 1 futures contract to another we incur a type of basis risk Under what circumstances are (a) a short hedge and (b) a long hedge appropriate? A short hedge is appropriate when a company owns an asset and expects to sell that asset in the future. It can also be used when the company does not currently own the asset but expects to do so at some time in the future 3. A long hedge is appropriate when a company knows it will have to purchase an asset in the future. It can also be used to offset the risk from an existing short position 3. Does a perfect hedge always lead to a better outcome than an imperfect hedge? A perfect hedge is one that completely eliminates the hedger’s risk. A perfect hedge does not always lead to a better outcome than an imperfect hedge. It just leads to a more certain outcome. 3. Consider a company that hedges its exposure to the price of an asset. Suppose the asset’s price movements prove to be favorable to the company. A perfect hedge totally neutralizes the company’s gain from these favorable price movements. An imperfect hedge, which only partially neutralizes the gains, might well give a better outcome. 3. 3. 3. 3. Source: Options, Futures, and Other Derivatives 6th Edition, Copyright © John C. Hull 2005 3. | 3. Hedging Strategies Using Futures Lecture #16 3. Changing Beta What position is necessary to reduce the beta of the portfolio to What position is necessary to increase the beta of the portfolio to 3. 3. Hedging Price of an Individual Stock Similar to hedging a portfolio Does not work as well because only the systematic risk is hedged The unsystematic risk that is unique to the stock is not hedged 3. 3. Why Hedge Equity Returns May want to be out of the market for a while. Hedging avoids the costs of selling and repurchasing the portfolio Suppose stocks in your portfolio have an average beta of , but you feel they have been chosen well and will outperform the market in both good and bad times. Hedging ensures that the return you earn is the risk-free return plus the excess return of your portfolio over the market. 3. Rolling The Hedge Forward (page 67-68) We can use a series of futures contracts to increase the life of a hedge Each time we .
