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 * * =
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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 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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