Lecture10 - Hedging with Futures and Forwards Instructor:...

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10-1 Hedging with Futures and Forwards Instructor : Dr. QU Baozhi Phone : (852) 27887312 Email: baozhiqu@cityu.edu.hk Office : P7407
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10-2 Overview Derivative securities have become increasingly important as FIs seek methods to hedge risk exposures. The growth of derivative usage is not without controversy since misuse can increase risk. This lecture explores the role of futures and forwards in risk management.
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10-3 Derivatives Futures and Forwards are the second largest group of interest rate derivatives in terms of notional (dollar) value and largest group of FX derivatives. Swaps are the largest. However, rapid growth of derivatives use has been controversial……
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10-4 Big Losses Involving Derivatives by Financial Institutions Société Générale (France, 2008) ($7.2 billion) Amaranth Advisors (U.S., 2006) ($6 billion) Allied Irish Bank ($700 million) Barings ($1 billion) Daiwa ($1 billion) Kidder Peabody ($350 million) LTCM ($4 billion) Midland Bank ($500 million) National Westminster Bank ($130 million)
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10-5 Spot Contract Spot Contract: an agreement involving the immediate exchange of an asset for cash. Agreement at t=0 for immediate delivery and immediate payment, or delivery versus payment . For example, a buyer pays $97 (spot bond quote) for a 20-year maturity bond per $100 of face value for immediate (time 0) delivery.
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10-6 Forward Contract Forward Contract Agreement involving the exchange of an asset for cash at a specified future date for a fixed price which is set at t=0. For example, in a three-month forward contract to deliver 20-year bonds, the buyer and seller agree on a price ($97 per $100 of face value) and quantity today (time 0). In three months’ time the seller delivers $100 of 20-year bonds and receives $97 from the buyer, no matter what happened to the spot price of 20-year bonds during the three months. Counterparty risk
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Futures Contract Futures Contract: an agreement involving the future exchange of an asset for cash at a price that is determined daily. Similar to a forward contract except Marked to market Futures are Exchange traded (standardized contracts) while forwards are tailor-made contracts. Lower default risk than forward contracts.
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.

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Lecture10 - Hedging with Futures and Forwards Instructor:...

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