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Workshop 4 Additional Question 1: Give Three Reasons Why The Treasurer of A Company Might Not Hedge The Company's

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5 views

Workshop 4 Additional Question 1: Give Three Reasons Why The Treasurer of A Company Might Not Hedge The Company's

Uploaded by

lieutruong.hanu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Workshop 4

Additional question 1
Under what circumstances are (a) a short hedge and (b) a long hedge appropriate?

Additional question 2
Explain what is meant by basis risk when futures contracts are used for hedging?

Book question 3.1


Explain what is meant by a perfect hedge. Does a perfect hedge always lead to a better outcome than
an imperfect hedge? Explain your answer.

Additional question 4
Give three reasons why the treasurer of a company might not hedge the company’s exposure to a
particular risk. Explain your answer.

Book question 3.3


Suppose that the standard deviation of quarterly changes in the prices of a commodity is $0.65, the
standard deviation of quarterly changes in a futures price on the commodity is $0.81, and the
coefficient of correlation between the two changes is 0.8. What is the optimal hedge ratio for a
three-month contract? What does it mean?

Book question 3.4


A company has a $20 million portfolio with a beta of 1.2. It would like to use futures contracts on the
S&P 500 to hedge its risk. The index futures is currently standing at 1080, and each contract is for
delivery of $250 times the index. What is the hedge that minimizes risk? What should the company
do if it wants to reduce the beta of the portfolio to 0.6?

Book question 3.8


Imagine you are the treasurer of a Japanese company exporting electronic equipment to the United
States. Discuss how you would design a foreign exchange hedging strategy and the arguments you
would use to sell the strategy to your fellow executives.

Book question 3.13


The standard deviation of monthly changes in the spot price of live cattle is (in cents per pound) 1.2.
The standard deviation of monthly changes in the futures price of live cattle for the closest contract is
1.4. The correlation between the futures price changes and the spot price changes is 0.7. It is now
October 15. A beef producer is committed to purchasing 200,000 pounds of live cattle on November
15. The producer wants to use the December live-cattle futures contracts to hedge its risk. Each
contract is for the delivery of 40,000 pounds of cattle. What strategy should the beef producer
follow?
2

Book question 3.15


On July 1, an investor holds 50,000 shares of a certain stock. The market price is $30 per share. The
investor is interested in hedging against movements in the market over the next month and decides
to use the September Mini S&P 500 futures contract. The index is currently 1,500 and one contract is
for delivery of $50 times the index. The beta of the stock is 1.3. What strategy should the investor
follow? Under what circumstances will it be profitable?

Book question 3.23


A company wishes to hedge its exposure to a new fuel whose price changes have a 0.6 correlation
with gasoline futures price changes. The company will lose $1 million for each 1 cent increase in the
price per gallon of the new fuel over the next three months. The new fuel's price change has a
standard deviation that is 50% greater than price changes in gasoline futures prices. If gasoline
futures are used to hedge the exposure what should the hedge ratio be? What is the company's
exposure measured in gallons of the new fuel? What position measured in gallons should the
company take in gasoline futures? How many gasoline futures contracts should be traded? Each
contract is on 42,000 gallons.

Book question 3.25


It is July 16. A company has a portfolio of stocks worth $100 million. The beta of the portfolio is 1.2.
The company would like to use the CME December futures contract on the S&P 500 to change the
beta of the portfolio to 0.5 during the period July 16 to November 16. The index is currently 1,000,
and each contract is on $250 times the index.
a) What position should the company take?
b) Suppose that the company changes its mind and decides to increase the beta of the portfolio
from 1.2 to 1.5. What position in futures contracts should it take?

Additional Problem

The S&P 500 index is currently priced at 1,000. A futures contract on the S&P 500 index is currently
priced at 1,010. Each futures contract is $250 times the index price. The dividend yield on the index is
0.25% per year. The risk-free rate is 1% per year. An equity portfolio is currently worth $5,050,000, and
the beta of this portfolio is 1.5. Suppose the S&P 500 index will be at 950 in one year, and the index
futures contract price will be 952.

As a portfolio manager, how can you hedge this portfolio for one year using the index futures contract
on the S&P500? Given the price scenario above, what is the value of the hedged position in one year?
Show all calculations.

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