Optimal Hedge Ratio

# Optimal Hedge Ratio - price times contract size 3 F A V V...

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Optimal Hedge Ratio Proportion of the exposure that should optimally be hedged is where σ S is the standard deviation of S , the change in the spot price during the hedging period, σ F is the standard deviation of F , the change in the futures price during the hedging period ρ is the coefficient of correlation between S and F . 1 F S h σ σ ρ =

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Optimal Number of Contracts The number of contracts to hedge the exposure is where Q A is size of the position hedged (units) Q F is size of one futures contract (units) 2 F A Q Q h N * * =
Hedging a Stock Portfolio Using Index Futures To hedge the risk in a portfolio the number of contracts that should be shorted is where VA is the current value of the portfolio, β is its beta, and VF is the current value of one futures (=futures

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Unformatted text preview: price times contract size). 3 F A V V β Reasons for Hedging an Equity Portfolio • Desire to be out of the market for a short period of time. (Hedging may be cheaper than selling the portfolio and buying it back.) • Desire to hedge systematic risk 4 Stock Picking • If you think you can pick stocks that will outperform the market, futures contract can be used to hedge the market risk • If you are right, you will make money whether the market goes up or down 5 Rolling The Hedge Forward • We can use a series of futures contracts to increase the life of a hedge • Each time we switch from 1 futures contract to another we incur a type of basis risk 6...
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Optimal Hedge Ratio - price times contract size 3 F A V V...

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