FMP 8. Using Futures for Hedging

Learning Objectives

1) Define and differentiate between short and long hedges and identify their appropriate uses.

2) Describe the arguments for and against hedging and the potential impact of hedging on firm profitability.

3) Define and calculate the basis, discuss various sources of basis risk, and explain how basis risks arise when hedging with futures.

4) Define cross hedging and compute and interpret the hedge ratio and hedge effectiveness.

5) Calculate the profit and loss on a short or a long hedge.

6) Compute the optimal number of futures contracts needed to hedge an exposure and explain and calculate the “tailing the hedge” adjustment.

7) Explain how to use stock index futures contracts to change a stock portfolio’s beta.

8) Explain how to create a long-term hedge using a stack-and-roll strategy and describe some of the risks that arise from this strategy.