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1Hedging with futures – Ch.3 Lecture outline•Introduction to hedging strategies using futures•Long/short hedging •Hedging outcomesWeek 3 - Hedging with futuresFINS 3635 Options, Futures, and Risk Management Techniques1•basis risk •hedge ratiosHedging with Futures•Use a futures position to reduce or eliminate the risk of the underlying asset price fluctuations.•What position (Long or Short)?•How many contracts (hedge ratio)? Week 3 - Hedging with futuresFINS 3635 Options, Futures, and Risk Management Techniques2•totally hedged (hedge ratio =1); •partially hedged (hedge ratio<1); •overly hedged (hedge ratio >1)•The size of a futures contract and the relationship between spot and futures prices during the hedging period have impact on the hedge ratio.Example of Long Hedge•A long hedge is a hedge involves a long position in futures contract to offset the short position in underlying asset. •Assume that it is now Mar 15. An investor needs to buy 100 shares of IBM stock on Dec 15. •Risk: spot price fluctuation on Dec 15Week 3 - Hedging with futuresFINS 3635 Options, Futures, and Risk Management Techniques3•Strategy to reduce risk: buy IBM stock futures with Dec. delivery (note that size of the futures contract is 100 and suppose that futures price is $98 per share now)
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