Question

Hedging Examples (pages 10-12) o buy) A US company will pay £10 million for imports from Britain in 3 months and decides to hedge using a long position in a forward contract An investor owns 1,000 Microsoft shares currently worth $28 per share. A two-month put with a strike price of $27.50 costs $1. The investor decides to hedge by buying 10 contracts

Answer 1

The answers are as follows:

Hedging is a technique not by which you we make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have reduced the profit you could have made , but if the investment losee money, then your hedge if successful will reduce that loss. I In case of first Example: The US company will expect value of pound to increase in 3 months time. So, US Compony taker LONG position in a forward market to hedge risk it would face if the value of pound increases iie. US com bony will buy Pound at today's rate but will toke delivery of Pound after 3 months.

After 3 months, il value of found really increases then the Company will not face. any forex loss as a 10 million received then will be delivered to the ex porten In case of Second Example: An investor expects the price of Microsoft shares will decrease in two months time. Hee Here, I lot, 100 shares ii 10 lot, 10X100 - 1000 shores. To protect himself from a fall in price of Microsoft shared , investor decides to buy a but option which gives a investor the right to sell Microsoft share at Strike Price of $27.50 by paying a premium of $1.

After the months, if the market price falls below $28, he starts to lose money. If the price falls below $27.50, he will exercise He controck & If the price falls below $27.50-1= $26.50, I he will start reu Total U [Price@Exha Pool it recovering his losses. egyepong content Boot it or Loss Exercise or NOT Exercise 29 -1 -1x1000 - 1000 Not Exercise -1 1 L -1X1000 = -6000 Not Exercise 27.50 -1 -1X1000--1000 Exercise 27 -0.50 -0.50X100 = -500 Exercise 26.50 1-1-0 0 Exercise 25 2.5-1=151.5 X1000 - 1500 Exercise Thus, we can see that he is immuned to falling price below $26.50 Hus, he has hedged himself against such fallo