4w FinEcon 2024fall v3

Summary

This 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

• 📊 **Cross Hedging**: Discusses the concept of hedging using futures contracts that are correlated but not identical to the underlying asset.
• 🔍 **Beta as a Measure**: Beta is used to measure the sensitivity and relationship between the underlying asset and the asset to be hedged.
• 💼 **Practical Example**: Provides an example of cross hedging by selling Samsung shares and using CP 200 futures to lock in the price.
• 📉 **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.
• 📈 **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.
• 📋 **Optimal Hedging Ratio**: Discusses how to determine the optimal hedging ratio based on beta and the value of the underlying asset and futures contract.
• 🚀 **Another Example**: Describes an airline hedging jet fuel purchases using heating oil futures, showing how to calculate the optimal number of contracts.
• 💡 **Hedging Strategy**: Emphasizes the importance of understanding when to take long or short futures positions for hedging purposes.
• 🌐 **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.
• 📚 **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

00:00

📊 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.

05:01

📉 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.

10:03

✈️ 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.

15:04

🔐 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.

Keywords

💡Hedging

Hedging is a risk management strategy used to protect against potential losses by taking an offsetting position in a related security. In the context of the video, it's used to mitigate the risk of price fluctuations in assets such as stocks or commodities. The video explains that hedging involves taking a short position in a future to lock in the price of an asset to be sold in the future, like the example of locking in the price of Samsung shares using CP 200 Futures.

💡Beta

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. It's used in the video to determine the optimal hedge ratio. A beta greater than 1 indicates that the asset is more volatile than the market, while a beta less than 1 suggests the opposite. The video uses beta to calculate the sensitivity of the underlying asset (Samsung) to the asset being hedged (CP 200 Futures).

💡Cross Hedging

Cross hedging is a strategy where an investor hedges a position with a related but not identical asset. The video explains that cross hedging occurs when the underlying asset of the future contract is not identical to the asset being hedged. For example, hedging Samsung shares using CP 200 Futures, which are based on a different index but are related through market movements.

💡Futures

Futures are financial contracts that obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. In the video, futures are used as a tool for hedging. The script mentions how one can take a short position in a future to hedge against the price risk of an asset they plan to sell in the future.

💡Hedge Ratio

The hedge ratio is the number of futures contracts needed to hedge a certain amount of the underlying asset. It's calculated based on the correlation between the asset being hedged and the futures contract. The video explains how to determine the optimal hedge ratio using beta, which reflects the sensitivity of the asset's price to the futures contract.

💡Basis Risk

Basis risk is the risk that the price of the hedged asset will move independently of the price of the hedging instrument. It's the difference between the spot price of the asset and its future price. The video discusses how basis risk arises from uncertainty about what the basis will be at the maturity of the hedge.

💡Underlying Asset

The underlying asset is the specific asset or group of assets that a derivative contract, such as a future or option, is tied to. In the video, the underlying asset is referenced in the context of futures contracts, such as the CP 200 index, which is used to hedge against the price of Samsung shares.

💡Short Position

A short position is a stance taken by an investor who sells a security or other asset that they do not currently own, with the hope that the asset price will decline, allowing them to buy it back at a lower price and profit from the difference. The video explains how taking a short position in a future can be used to hedge against the potential decline in the price of an asset.

💡Long Position

A long position is the opposite of a short position, where an investor owns a security or other asset and expects its price to rise. In the context of the video, taking a long position in a future is mentioned as a way to hedge if you expect the price of an asset you plan to buy in the future to increase.

💡Maturity

Maturity refers to the expiration date of a financial instrument, such as a future or an option. The video discusses how the outcome of a hedge is influenced by the price movements of the underlying asset and the hedging instrument up to the maturity date.

💡Spot Price

The spot price is the current market price of an asset at a specific time. In the video, the spot price is mentioned in relation to the basis risk, which involves the difference between the spot price of an asset and its future 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