FINM3405L2 - Basic Principles of Hedging i i i l f d i...

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Lecture 2 edging With Forwards Hedging With Forwards and Futures Contracts Basic Principles of Hedging ± People hedge when they are exposed to the ovement in the price of an asset movement in the price of an asset ± Idea of hedging is to enter a derivatives position that provides a payoff that offsets price movements in the particular asset ± The aim is to eliminate (or at least reduce) the xposure to the price movements exposure to the price movements ± Strategy: entify your risk/exposure in the asset Identify your risk/exposure in the asset – Enter a derivatives position that makes money when the asset does poorly Short Hedge and Long Hedge ± A short hedge involves a short forward/futures osition Appropriate when: position. Appropriate when: – When hedger already owns asset and expects to sell it in the future. – When asset is not yet owned, but it will be owned at sometime in the future ± A long hedge involves a long forward/futures position. – Appropriate when a purchase is scheduled to be made in ture, therefore exposed to rising prices. future, therefore exposed to rising prices. Overview of Equity Market Indices ± Stock index tracks changes in a hypothetical portfolio f stocks of stocks ± S&P construct indices in Australia &P/ASX 20 50 100 200 300 MidCap50 SmallOrdinaries – S&P/ASX 20, 50, 100, 200, 300, MidCap50, SmallOrdinaries ± S&P/ASX200 is a value-weighted index of the Top 00 Australian stocks 200 Australian stocks – Daily index change is an average of price change on each stock, with weights determined according to market cap – Dividends paid by stocks not included in index (however, total return index might also be constructed)
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± Fund managers often try to construct portfolios to ‘ rack’ a market index track a market index ± They are benchmarked to that index and their erformance is evaluated relative to that index performance is evaluated relative to that index ± This partly explains the popularity of derivatives like e SPI200 futures contract and the ASX200 index the SPI200 futures contract and the ASX200 index options for hedging SFE SPI200 Futures Contract Specifications: SPI200 Index Futures Contract unit: Valued at $A25 per index point pp Contract months: March/June/September/December up to six quarters ahead Last trading day: The third Thursday of the contract month. All trading in expiring contracts ceases at 12.00pm on the Last Trading Day. Settlement method and price: Cash settlement. The settlement price is the Special Opening Quotation on the S&P/ASX200 Index on the Last Trading Day. The Opening Quotation is is calculated using the first traded price of each component stock in the S&P/ASX200 Index.
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This note was uploaded on 08/27/2009 for the course FINM 3405 taught by Professor Philipgray during the Three '09 term at Queensland.

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FINM3405L2 - Basic Principles of Hedging i i i l f d i...

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