FIN 3506 Lecture Notes - Lecture 3: Futures Exchange, Futures Contract, Spot Contract

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bronzeturtle979

6 Oct 2016

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Hedging is the process of reducing the risk in a cash market position by using futures contracts. To do this you take the opposite position in the futures market that you have in the cash market. The main object is to lock in the price of the commodity. Hedges are classified by the position taken in the futures markets. A short hedge is used to hedge a long position in the cash or spot market by taking a short position in the futures contract. A long hedge is used when the hedger has a short position in the cash or spot commodity and therefore takes a long position in the futures contract: short hedges. Example: you have 1000 oz. of gold that you will produce in the next three months and will sell at the end of the three months. The current price of gold is per oz. Each gold futures contract is for 100 oz of gold.

Related Questions

1. Futures Contracts Describe the general charac- teristics of a futures contract. How does a clearinghouse facilitate the trading of financial futures contracts?

2. Futures Pricing How does the price of a financial futures contract change as the market price of the security it represents changes? Why?

3. Hedging with Futures Explain why some futures contracts may be more suitable than others for hedging exposure to interest rate risk.

4. Treasury Bond Futures Will speculators buy or sell Treasury bond futures contracts if they expect interest rates to increase? Explain

7. Hedging with Futures Assume a financial institution has more rate-sensitive assets than rate-sensitive liabilities. Would it be more likely to be adversely affected by an increase or a decrease in interest rates? Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

8. Hedging with Futures Assume a financial institution has more rate-sensitive liabilities than rate- sensitive assets. Would it be more likely to be adversely affected by an increase or a decrease in interest rates.

Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

9. Hedging Decision Why do some financial insti- tutions remain exposed to interest rate risk, even when they believe that the use of interest rate futures could reduce their exposure?

10. Long versus Short Hedge Explain the difference between a long hedge and a short hedge used by financial institutions. When is a long hedge more appropriate than a short hedge?

11. Impact of Futures Hedge Explain how the probability distribution of a financial institutionâs returns is affected when it uses interest rate futures to hedge. What does this imply about its risk?

12. Cross-Hedging Describe the act of cross-hedging. What determines the effectiveness of a cross-hedge?

ivorywombat545

1. Which of the followings reduce(s) credit risk in futures contracts?

(1) Standardization of futures contracts

(2) Trading in exchanges

(3) Marking to market

A. Only (1)

B. Only (2)

C. Only (3)

D. Only (1) and (3)

E. All of (1), (2) and (3)

2. Letâs distinguish the meanings of transaction types of Buy, Sell, Short and Cover. If you want to speculate on price movement and expect the price of a certain option is expected to fall, then which transaction do you have to do?

A. buy

B. sell

C. short

D. cover

3. What does âcontract sizeâ mean in derivatives trades?

A. Number of contracts

B. Dollar value of one contract

C. Dollar value of the total contracts

D. Number of unit that denominates the asset per one contract

4. Suppose you are a speculator and expecting the price of soybeans to fall in three months. (You donât have soybeans) Which transaction do you have to make in the futures market?

A. Buy

B. Sell

C. Short

D. Cover

5. Suppose you are a fund manager and worrying about risk arising from the uncertain performance of the market as a whole. In order to reduce risk, which position of index futures do you have to take?

A. Buy

B. Sell

C. Short

D. Cover

6. Which of the following conditions does NOT cause the basis risk in hedge using futures?

a. Length of time to hedge is shorter than the length of time for futures to expire.

b. Length of time to hedge is longer than the length of time for futures to expire.

c. The underlying asset of futures is not the same as the asset to be hedged

d. The amount to be hedged is different from the amount of futures contracts

Derivative Contracts

Explain how a market participant can use interest rate derivative contracts to hedge risks.
The explanation should include a description of what position the manager would take
(i.e., long or short; pay fixed or receive fixed); it is not sufficient simply to say that the
manager would âuseâ a contract.

(a) A lender is concerned with a decline in 3-month LIBOR. How can the lender hedge using
the Eurodollar futures contract?




(b) A borrower is concerned with an increase in 3-month LIBOR. How can the borrower
hedge using the Eurodollar futures contract?




(c) A portfolio manager is concerned with an increase in interest rates over the next quarter.
How can the manager use a Treasury bond futures contract to hedge?




(d) A portfolio manager is concerned with an increase in interest rates. How can the
manager use an interest rate swap contract to hedge?




(e) A portfolio manager is concerned with the credit risk of a corporate bond it holds
in its portfolio. How can the manager use a credit default swap to hedge the credit
risk instead of selling the corporate bond?

ultramarinehornet16

FIN 3506 Lecture Notes - Lecture 3: Futures Exchange, Futures Contract, Spot Contract

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