Forward and Futures Hedging, Spread, and Target Strategies
CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD, AND TARGET STRATEGIES
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Short hedge and long hedge) Another type of hedge situation is faced when a party plans to purchase an asset at a later date, such as a bread maker. Fearing an increase in wheat prices, the bread maker would buy futures contracts. Then, if the price of wheat increases, the wheat futures price also will increase and produce a profit on the futures position. That profit will at least partially offset the higher cost of purchasing wheat. This is a long hedge, because the hedger, the bread maker here, is long in the futures market. Because it involves an anticipated transaction, it is sometimes called an anticipatory hedge.
2. (Spread Strategies) The implied repo on a cash-and-carry transaction with the nearby futures is the return from buying an asset and selling it at the futures price at the expiration date of the futures. Thus, it is a spot rate. The implied repo rate from a spread is the return from a transaction involving the purchase of the asset at a given futures price at the expiration of the nearby futures contract and the sale of the asset at another futures price at the expiration of the deferred futures contract. Thus, it is a forward rate. The two rates are connected by the normal relationship between spot and forward rates but they certainly need not be the same.
3. (The Basis) a. The dealer is long sugar in the spot market and should sell sugar futures to set up a hedge
S0 = 0.0479 f0 = 0.0550 b0 = S0 – f0 = 0.0479 – 0.0550 = –0.0071 π = ST – S0 – (fT – f0)
We are not given ST but it will not matter since ST and fT will cancel. So make up a value of ST, say 0.0465.
π = 0.0465 – 0.0479 –(0.0465 – 0.0550) = 0.0071
In terms of the basis,
π = – b0 + bt = – (–0.0071) + 0 = 0.0071
In dollars,
π = 112,000($0.0071) = $795.20
Thus, the profit on the hedge is –1 times the
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Short hedge and long hedge) Another type of hedge situation is faced when a party plans to purchase an asset at a later date, such as a bread maker. Fearing an increase in wheat prices, the bread maker would buy futures contracts. Then, if the price of wheat increases, the wheat futures price also will increase and produce a profit on the futures position. That profit will at least partially offset the higher cost of purchasing wheat. This is a long hedge, because the hedger, the bread maker here, is long in the futures market. Because it involves an anticipated transaction, it is sometimes called an anticipatory hedge.
2. (Spread Strategies) The implied repo on a cash-and-carry transaction with the nearby futures is the return from buying an asset and selling it at the futures price at the expiration date of the futures. Thus, it is a spot rate. The implied repo rate from a spread is the return from a transaction involving the purchase of the asset at a given futures price at the expiration of the nearby futures contract and the sale of the asset at another futures price at the expiration of the deferred futures contract. Thus, it is a forward rate. The two rates are connected by the normal relationship between spot and forward rates but they certainly need not be the same.
3. (The Basis) a. The dealer is long sugar in the spot market and should sell sugar futures to set up a hedge
S0 = 0.0479 f0 = 0.0550 b0 = S0 – f0 = 0.0479 – 0.0550 = –0.0071 π = ST – S0 – (fT – f0)
We are not given ST but it will not matter since ST and fT will cancel. So make up a value of ST, say 0.0465.
π = 0.0465 – 0.0479 –(0.0465 – 0.0550) = 0.0071
In terms of the basis,
π = – b0 + bt = – (–0.0071) + 0 = 0.0071
In dollars,
π = 112,000($0.0071) = $795.20
Thus, the profit on the hedge is –1 times the