4w FinEcon 2024fall v3
Summary
TLDRThis script discusses the concept of hedging using futures contracts to mitigate risk. It explains the role of beta as a sensitivity measure for determining the optimal hedge ratio. The script provides examples of cross-hedging, where the underlying asset and the asset to be hedged are not identical, and how to calculate the necessary futures contracts for effective hedging. It also touches on basis risk, which arises from the uncertainty of the difference between the spot and futures prices at maturity. The importance of understanding when to take long or short futures positions for hedging is emphasized.
Takeaways
- đ **Cross Hedging**: Discusses the concept of hedging using futures contracts that are correlated but not identical to the underlying asset.
- đ **Beta as a Measure**: Beta is used to measure the sensitivity and relationship between the underlying asset and the asset to be hedged.
- đŒ **Practical Example**: Provides an example of cross hedging by selling Samsung shares and using CP 200 futures to lock in the price.
- đ **Hedging Outcomes**: Explains that the outcome of cross hedging may slightly differ from the target due to differences in price changes between the underlying asset and the futures contract.
- đ **Basis Risk**: Highlights the risk that arises from the uncertainty of the basis, which is the difference between the spot price of an asset and its future price.
- đ **Optimal Hedging Ratio**: Discusses how to determine the optimal hedging ratio based on beta and the value of the underlying asset and futures contract.
- đ **Another Example**: Describes an airline hedging jet fuel purchases using heating oil futures, showing how to calculate the optimal number of contracts.
- đĄ **Hedging Strategy**: Emphasizes the importance of understanding when to take long or short futures positions for hedging purposes.
- đ **Basis Between Assets**: Illustrates the concept of basis by comparing the prices of different but related assets, such as CP 200 and Samsung stock, or heating oil and jet fuel.
- đ **Educational Session**: Concludes with a reminder of the importance of understanding hedging concepts, especially the timing and direction of futures positions relative to the asset being hedged.
Q & A
What is the optimal hedge ratio and how is it determined?
-The optimal hedge ratio can be determined by Beta, which represents the sensitivity and relationship between the underlying asset and the asset to be hedged. It indicates how much of one asset is needed to hedge another.
What is meant by 'cross hedging' in the context of the transcript?
-Cross hedging refers to the practice of using a different but correlated asset to hedge against the risk of an underlying asset. This is done when the assets are not identical.
Can you provide an example of cross hedging from the transcript?
-Yes, an example given is where one would sell one share of Samsung in one year and hedge using CP 200 Futures, which is a different but related asset to Samsung stock.
How does the number of contracts needed for hedging in cross hedging scenarios get calculated?
-The number of contracts needed for cross hedging is calculated using the optimal hedge ratio, which takes into account the Beta and the value of the underlying asset and the futures contract.
What is the significance of Beta in the context of hedging?
-Beta is used as an indicator for the relationship between the underlying asset and the asset to be hedged. It helps determine the optimal hedge ratio.
What is basis risk and how does it relate to hedging?
-Basis risk is the risk that the price move of the hedged asset will not perfectly correlate with the price move of the hedging instrument. It arises from the uncertainty of the difference between the spot price of an asset and its future price.
How does the change in the price of the underlying asset and the hedging instrument affect the hedging outcome?
-The change in price can result in a difference between the target price and the actual amount received upon hedging, which is due to the non-identical nature of the underlying asset and the hedging instrument.
What is the role of the multiplier in calculating the value of a futures contract?
-The multiplier is used to determine the value of one futures contract by multiplying it with the index value. For example, if the index value is 300 and the multiplier is 100, then the value of one contract is 30,000.
What is the outcome of a cross hedging strategy if the price of the underlying asset and the hedging instrument both go down?
-If both the underlying asset and the hedging instrument prices go down, the hedger will receive less from selling the asset but will also gain more from the short position in the hedging instrument.
Why is hedging important for a business?
-Hedging is important for a business to reduce risk, especially exchange rate risk. It allows the business to focus on its core operations without being exposed to unpredictable market fluctuations.
Can you explain the concept of taking a long or short position in futures for hedging?
-Taking a long position in futures for hedging means buying futures contracts to lock in a price for a future sale. Conversely, taking a short position means selling futures contracts to lock in a price for a future purchase.
Outlines
đ Hedging with Cross-Setting
This paragraph discusses the concept of cross-setting, a form of hedging where the underlying asset and the asset to be hedged are not identical. It introduces the idea of using beta, a sensitivity measure, to determine the optimal hedge ratio (H). The explanation includes a practical example of cross-setting where an individual, Kab, plans to sell a share of Samsung in one year and uses the CP 200 Futures to lock in the price by taking a short position. The calculation involves determining the number of contracts needed based on the value of the underlying asset and the index value, which is multiplied by a factor (100 in this case). The optimal PCH ratio is calculated to manage the hedge effectively.
đ Cross-Setting Outcomes and Basis Risk
The second paragraph delves into the outcomes of cross-setting at time t0, illustrating how the price changes of the underlying asset (Samsung) and the hedging instrument (CP 200 Futures) can lead to gains or losses. It explains the calculation of net amounts and gains from futures contracts, emphasizing that the gains from a short position are the opposite of those from a long position. The paragraph also introduces the concept of basis risk, which arises from the uncertainty of the difference between the spot price of the asset and the future's price at maturity. It concludes with an example where the actual result slightly differs from the target due to the inherent variability in cross-setting.
âïž Hedging with Futures: An Airline Example
This section presents another example of hedging, this time with an airline planning to purchase jet fuel and using heating oil futures for hedging. It explains how historical data is used to calculate beta, which represents the sensitivity of the price change between jet fuel and heating oil. The optimal hedge ratio is determined based on this sensitivity. The example demonstrates how the airline can use futures contracts to mitigate the risk of price fluctuations, although it also highlights that the products are not identical, indicating a basis risk.
đ Understanding Hedging Concepts
The final paragraph summarizes the key concepts of hedging, emphasizing the importance of understanding when to take a long or short position in futures for effective hedging. It discusses basis risk in the context of cross-hatching and the need to decide on optimal hedging in the face of this risk. The speaker concludes by reinforcing the importance of grasping these concepts for practical application in hedging strategies.
Mindmap
Keywords
đĄHedging
đĄBeta
đĄCross Hedging
đĄFutures
đĄHedge Ratio
đĄBasis Risk
đĄUnderlying Asset
đĄShort Position
đĄLong Position
đĄMaturity
đĄSpot Price
Highlights
The optimal hedge ratio can be determined by Beta, which measures the sensitivity between the underlying asset and the asset to be hedged.
Cross hedging involves using futures on an asset that is not identical to the asset being hedged.
Beta can be used as an indicator for cross hedging when the underlying asset of the future contract is not identical with the asset to be hedged.
An example of cross hedging is selling one share of Samsung and using CP 200 Futures to lock in the price.
The value of one futures contract is equal to the value of the index times a multiplier.
The number of contracts needed for hedging can be calculated using the optimal hedge ratio.
The net amount from cross hedging can be calculated by considering the change in the price of the underlying asset and the futures contract.
Cross hedging cannot guarantee an exact hedge due to the difference in price changes between the underlying asset and the asset being hedged.
Basis risk arises from the uncertainty of the basis, which is the difference between the spot price of an asset and its future price.
The optimal hedge should be decided based on the sensitivity value (Beta) between the futures and the asset to be hedged.
An example of cross hedging in the airline industry is purchasing jet fuel and hedging using heating oil futures.
The optimal hedge ratio is calculated based on the historical data and the relationship between the underlying assets.
Hedging is a way to reduce risk without betting on exchange rates or other financial variables that are not the main business focus.
The concept of hedging involves taking a long future position to hedge a future sale, and a short future position to hedge a future purchase.
The importance of understanding when to take a long or short position in futures for hedging purposes.
The session concludes with a reminder of the basic concepts of hedging and the importance of understanding them.
Transcripts
this
information uh we can
uh say portion of exposure that should
optimally be hat a
better uh we are still talking about
cross setting cross setting should be
coming from where underly asset of
Futures and asset to be hated they're
not identical they are different in that
case we are taking on the cross setting
so optimal hch ratio can be can be
determined by Beta beta is sensitivity
and also we can say this is H
ratio and forget about this one I think
two uh you know too much technical for
you so still we focus on
this
formula see we uh
discussed what is beta beta a is
relationship between underlying asset
and asset to be H so better you know can
be uh used for indicator when we are
going to have cross
seting so Crossing uh again you know you
uh Place uh in know be reminded a
crossing
a can be uh you
know assessed where underlying asset of
you know future contract is not
identical with asset to be hatched so
example one uh this is cross hatching so
cab will sell one share of samung in one
year and and H uh using
CP 200
Futures see which is exactly you know
kab kab will be uh you know selling one
share of Samsung in one
year so he like to you know un lock in
the price by using
CP 200
Futures how he's going to do that take
short
position
short
future yeah cost p uh 200
future short
position here you know we need to uh see
uh there is some convention now
index we have and how much a value for
one future contract so
usually one
contract is equal
to the value
of
index
times multiplier here 100
this is the value of one
contract we need to uh find out how many
uh contract cop need to sell for
hatching at T where Samsung is
70,000 cost be 200 is
300 to gain uh number of contract with
optimal PCH ratio is like
this let's see what it is now beta is
sensitivity relationship between Samsung
and HP
200 the Samsung value is the the asset
to be
H and the valueable one contract is
underlying
asset you are going to uh take
position of
P so V
H2 we already uh decided in the previous
uh page now Samsung uh one Share value
is
70,000 and
one contract value
is 30,000 30,000 is coming from
300 this is index t0 and times multiply
100 and how much uh you know how many uh
contract you are going to take a
short
4.66 so Calum need to sell
4.66 contract of po p to the future to
Ling Samsung
price
see and what the result of a cross
setting at t0 Samsung
70,000 KW index cost P 200
300 in one year
Samsung change to to
78400 and
CP index change
to
315 now what is net
amount K we're going to sell one share
and then uh we receive 78 400
KW at in one year because this is price
in one year at one year and then he can
sell it out without with the price he
receive this
amount and what is gain from your future
see you you already uh in a
seen
initial future
price and
then maturity uh future price if take a
long position what is your gain gain
is
F1 minus
F uh sorry your gain
is f 2 minus
F1 this gain from long position long
future yeah this is the
game
here cab took position of what
sh so
gain is opposite opposite of this
so
negative F2 minus fub1 because this gain
from long position now you take opposite
position which is short so gain should
be upside down so gain will be like this
then F1 minus
F2 this is again from
short position so
now from Samsung
share and uh C receive uh
78400 one at one year and then from
short
position how many contract
4.66 and multiplier
100 what is f F1 this is 300 what is
F2
315
then amount
is uh here in negative
6,99 Z at this is loss so one and 1 +
two and we'll get uh around
71
410 the C Target is he like to lock in
70,000 but
here his result is around 71
uh, slightly uh different from
7,000 but this is due to you know
crossing
crossing cannot guarantee exactly in a
hatching because under the price of
underlying asset and the price of asset
to be hatched those are not identical so
change of price could be different
that's why small uh in know uh gap
between Target price and actual amount
there could be some
Gap and what if uh in
know the price going down then
70,000 to 63 uh
70,000 to
63,000 and Co P 300 to uh
285 Samsung and cosp 200 both going down
original
amount car up and sell one share at
63,000 so he will receive this amount
63,000 and what gain from short position
4 4.66 this contract number of contract
and then 100 multiplier and this is F1
this is
F2 so here gain is
6,9
90 so 1 + 2 is this amount this is close
to in know
70,000 but not really equal yeah this is
uh one uh you know a result from cross
hatching the other
example the airline will purchase 2
million gallon of J fuel in one
month
and hat using heting oil
Futures jet fuel price and heating oil
uh price these are slightly
different so not the same
product one
contract is one contract of future is 42
gallon this is
information um from historical data beta
is 78 which
means which
means that P price change
Lely equal
to
eating
oil yeah price
change this
is regression in know
formula so
here this one beta H optimal H
ratio like
this
the asset to be Hatchet 2 million
galon one contract of future
42,000 so we we can solve well
to
have the optimal Hatchy contract
is 37
contract this is what it is from you
know cross hatching based on
sensitivity vaa based on relationship
between underline s of Futures and asset
to be
hatched okay uh uh let's uh you know
close this uh session so Hing is a way
to uh reduce the
risk
without Hing probably C is exposed
to what 4ing exchange
risk that is uh not you know K main
business K main business is selling good
uh you know gimchi product and make a
you know can I mean make a gain at not
betting on uh you know USD uh dollar so
that why you know take position of FX
forward against $5
million to be received in three months
so we already uh discussed so Hing is a
way to reduce risk an important concept
is in Hing is a basis
risk basis risk in in terms of Crossing
we have seen already in a basis between
cby 200 and the Samsung uh stock price
and also bases between heating oil and
the jet
fuel that basis is the difference
between spot price of an asset and it's
a future
price so basis risk rise from a Hatcher
uncertainty as to what the basis will be
and maturity of the hatches so optimal
Hing should be decided in case of
processing yeah we uh reviewed
already I think uh from technical
perspective uh it's not really uh easy
to understand but concept is concept is
when uh you're are going to take a long
future position for Hing and when you're
going to take a short position for
hatching that should be that should be
understood see you
have so you are you
have
S and you are going to sell it in one
year and you like to lock in the price
in case what are you going to
do
show
future position yeah you take a short
future position for
hatching
uh
sell
asset at one year
yeah in the case uh too lucky you take a
short position
long is set at one
year how to lock in the price take
a
long
future
position this is you know a basic
concept but which is also important
please uh you know uh remember uh when
you are going to take a short future
against what when you are going to take
a long future against what that should
be yeah that should be uh cleared from
uh your understanding okay yeah I think
uh you know time to uh close uh today's
session uh see you next week thank you
5.0 / 5 (0 votes)