FBE459_1_2b_Futures_Hedging(1)

FBE459_1_2b_Futures_ - FBE 459 Financial Derivatives Prof Pedro Matos Lecture 1.2(b Futures Pricing and Hedging(Part B Convergence and Basis Risk

Info iconThis preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon
FBE 459 – Financial Derivatives Prof. Pedro Matos Lecture 1.2(b): Futures Pricing and Hedging (Part B) Convergence and Basis Risk Hedging and Cross-Hedging Readings: HULL chapters 3, 5
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 - 1.2.(a): Determining Forward Prices . Arbitrage Pricing - 1.2.(b): Hedging (*today*) . Convergence and Basis Risk . Contango and Backwardation . Hedging and Cross-Hedging Lecture 1.2 Outline:
Background image of page 2
3 In the News: Jan24, 2008: reports that a massive loss by a “rogue” trader trading futures costed Societe Generale (SocGen, very large French bank) a loss of EUR 5bln …
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 In the News: Other (in)famous cases on “rogue” traders
Background image of page 4
5 In the News: Other (in)famous cases on “rogue” traders Sumitomo Corp. (1996, $2.6 billion): Yasuo Hamanaka, "Mr. Copper“- tried to corner the market and spent billions buying it to boost its price. Pleaded guilty to fraud and forgery charges and was jailed for eight years Barings Bank (1995, $1.3 billion): Nick Leeson, Singapore-based futures trader, then 28, was jailed in 1995 after he ran up a loss of $1.3 billion on trades that eventually toppled Barings Bank, one of Britain's oldest merchant banks. Barings was subsequently sold to Dutch bank ING for one pound And … (we’ll talk about him when we cover Options)
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
6 How much can you loose in a futures position?
Background image of page 6
7 Hedging: Hedger = person with pre-existing position who uses futures to reduce or eliminate the price risk of the asset. A long futures hedge is appropriate if need to purchase an asset in the future and want to lock in the price if short asset Buy futures A short futures hedge is appropriate if need to sell the asset in the future and want to lock in the price If long asset Sell futures Who should be long gold futures: gold miner or jeweler?
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
8 Ex: hedger who is long the asset and short the futures position on underlying if asset price increases … if asset price decreases … = 0 Perfect Hedging: position on futures = 0 hedged position note: =0 only if perfect hedging !
Background image of page 8
9 “Not-So-Perfect” Hedging: Time(t) S t (Spot Price) F t (Futures Price) t=0 t=t 2 Prices t=t 1 t=T Real-world issues with hedging using futures - Convergence of futures to spot : F T ≈ S T - Basis Risk: the basis (= S t – F t ) can fluctuate a lot! ex: long futures hedge if initiated at t= t 1 and closed at t= T if initiated at t= t 1 and closed at t= t 2
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
10 Basis Risk: Basis = S t – F t = = Spot of price to hedge – Futures contract price . Why is there basis? Asset to be hedged may not be exactly the same as the asset underlying the futures contract - difference in quality - difference in location - calendar difference Basis risk = the uncertainty about the basis when the hedge is closed • at t=T, Basis T = S T – F T = 0 !
Background image of page 10
Basis Risk: Example: California Oranges Basis = S t – F t = = Spot of price to hedge (CA oranges) - Futures contract price (FCOJ is on FL oranges) . Why is there basis? - difference in quality / location / calendar
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 12
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 02/23/2011 for the course FBE 459 taught by Professor Matos during the Spring '08 term at USC.

Page1 / 56

FBE459_1_2b_Futures_ - FBE 459 Financial Derivatives Prof Pedro Matos Lecture 1.2(b Futures Pricing and Hedging(Part B Convergence and Basis Risk

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online