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Supplemental_Futures - Step-by-Step Hedging Procedure Step 1 Risk analysis of underlying cash position exposure Step 2 Quantification of impact on

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Saunders and Cornett, Financial Institutions 1 Step-by-Step Hedging Procedure Step 1 Risk analysis of underlying cash position exposure. Step 2 Quantification of impact on the cash position of interest rate/exchange rate changes. Step 3 State the goal of the hedge Step 4 Set up perfect hedge to use as a benchmark to implement hedge.
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Saunders and Cornett, Financial Institutions 2 Macrohedge Procedure Step 1 Step 2 Step 3 Step 4 Interest rate risk Cash flows when: Hedge goal: + cash flows when: Examples of hedge: Dur. Gap > 0 Interest rates Interest rates : Short hedge Sell financial futures Buy put options Dur. Gap < 0 Interest rates Interest rates : Long hedge Buy financial futures Buy call options Exchange rate risk Net exposure > 0 Exchange rates Exchange rates : Short hedge Sell forwards Buy put options Net exposure < 0 Exchange rates Exchange rates : Long hedge Buy forwards Buy call options
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In each of the following cases, indicate whether it would be appropriate to buy or sell a futures contract to hedge the appropriate risk. a. A commercial bank plans to issue CDs (borrow) in three months. The bank should sell futures contracts to protect against an increase in interest rates . b. An insurance company plans to buy bonds (invest) in two months. The insurance company should buy futures contracts to protect against a decrease in interest rates. c. A thrift is going to sell Treasury securities it holds in its investment portfolio next month. The thrift should sell futures contracts to protect against an increase in interest rates . d. A finance company has assets with a duration of six years and liabilities with a duration of 13 years. The finance company should buy futures contracts to protect against decreasing interest rates that would cause the value of liabilities to increase more than the value of assets, thus causing a decrease in equity value. Saunders and Cornett, Financial Institutions 3
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Saunders and Cornett, Financial Institutions 4 Futures/Forwards: A Definition The obligation to buy (long) or sell (short) An underlying financial security At a predetermined price PF = futures or forwards price On a preset date – the delivery date. If futures prices increase,
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This note was uploaded on 11/10/2011 for the course ECON 4620 taught by Professor Victorwakeling during the Fall '11 term at Kennesaw.

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Supplemental_Futures - Step-by-Step Hedging Procedure Step 1 Risk analysis of underlying cash position exposure Step 2 Quantification of impact on

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