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ecg590i_lecture04 - ECG590I Asset Pricing Lecture 4 Hedging...

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ECG590I Asset Pricing. Lecture 4: Hedging Using Futures 1 4 Hedging Using Futures 4.1 Types of hedges using futures Two types of hedge: short and long. 1. Short hedge ° Take a short position in the futures market. ° Appropriate when you will sell in the future at the prevailing spot price an asset you already own and you want to guarantee the price. John Seater, North Carolina State University, Fall 2007
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ECG590I Asset Pricing. Lecture 4: Hedging Using Futures 2 ° Example: I will sell 1 million barrels of crude oil in 3 months. The 3-month futures price is $18.75 per barrel. ° Short 1 million barrels of oil with a 3-month futures contract at $18.75 per barrel. ° If the spot price in 3 months is $17.50: I gain $18.75-$17.50=$1.25 per barrel from the futures contract (I buy 1 million barrels at the spot price of $17.50 and sell it at the contracted futures price of $18.50) but I sell the oil I already own for the spot price of $17.50 per barrel. The futures gain cancels the spot loss, and in e/ect I end up getting $18.75 per barrel. ° Spot price in three months proves to be $19.50: I lose $19.50- $18.75=$0.75 per barrel from the futures but I sell the oil for $0.75 more per barrel. I end up getting $18.75 per barrel. John Seater, North Carolina State University, Fall 2007
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ECG590I Asset Pricing. Lecture 4: Hedging Using Futures 3 2. Long hedge ° Take a long position in the futures market. ° Appropriate for someone who expects to buy an asset in the future at the prevailing spot price and wants to guarantee the price. 3. Reason to hedge ° You want to make a pro°t from your operations (e.g., turning wood into furniture) in the absence of price movements. ° You have no interest in speculating on price movements. ° Hedging insulates you operations pro°t from price uncertainty. John Seater, North Carolina State University, Fall 2007
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ECG590I Asset Pricing. Lecture 4: Hedging Using Futures 4 4.2 Basis and basis risk ° Perfect hedge does not always exist ° The asset we are trying to hedge may not be exactly the same as the asset underlying the futures. For example, you may be selling gasoline but futures contracts are available only for crude oil.
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  • Fall '08
  • msmorril
  • North Carolina State University, North Carolina State, Carolina State University, John Seater, ECG590I Asset Pricing

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