FRMJorion 14 Hedging Linear Risk

http://pluto.huji.ac.il/~mswiener/zvi.
html

972-2-588-3049 FRM
Zvi Wiener
Following
P. Jorion, Financial Risk Manager Handbook
Financial Risk Management
http://pluto.huji.ac.il/~mswiener/zvi.html

972-2-588-3049 FRM
Chapter 14
Hedging Linear Risk
Following P. Jorion 2001
Financial Risk Manager Handbook
Ch. 14, Handbook Zvi Wiener slide 3
Hedging
Taking positions that lower the risk profile of
the portfolio.
Static hedging
Dynamic hedging
Unit Hedging with Currencies
A US exporter will receive Y125M in 7
months.
The perfect hedge is to enter a 7-months
forward contract.
Such a contract is OTC and illiquid.
Instead one can use traded futures.
CME lists yen contract with face value
Y12.5M and 9 months to maturity.
Sell 10 contracts and revert in 7 months.
Market data 0 7m P&L
time to maturity 9 2
US interest rate 6% 6%
Yen interest rate 5% 2%
Spot Y/$ 125.00 150.00
Futures Y/$ 124.07 149.00
667 , 166 $
125
1
150
1
125 =
|
.
|
\
|
M Y
621 , 168 $
07 . 124
1
149
1
5 . 12 10 =
|
.
|
\
|
M Y
Stacked hedge - to use a longer horizon and
to revert the position at maturity.
Strip hedge - rolling over short hedge.
Basis Risk
Basis risk arises when the characteristics of
the futures contract differ from those of the
underlying.
For example quality of agricultural product,
types of oil, Cheapest to Deliver bond, etc.
Basis = Spot - Future
Cross hedging
Hedging with a correlated (but different) asset.
In order to hedge an exposure to Norwegian
Krone one can use Euro futures.
Hedging a portfolio of stocks with index future.

FRM-00, Question 78
What feature of cash and futures prices tend to make
hedging possible?
A. They always move together in the same direction
and by the same amount.
B. They move in opposite direction by the same
amount.

C. They tend to move together generally in the same
direction and by the same amount.
D. They move in the same direction by different
amount.
FRM-00, Question 78
What feature of cash and futures prices tend to make
hedging possible?
A. They always move together in the same direction
and by the same amount.
B. They move in opposite direction by the same
amount.

C. They tend to move together generally in the same
direction and by the same amount.
D. They move in the same direction by different
amount.
FRM-00, Question 17
Which statement is MOST correct?
A. A portfolio of stocks can be fully hedged by
purchasing a stock index futures contract.
B. Speculators play an important role in the futures
market by providing the liquidity that makes
hedging possible and assuming the risk that hedgers
are trying to eliminate.

C. Someone generally using futures contract for
hedging does not bear the basis risk.
D. Cross hedging involves an additional source of
basis risk because the asset being hedged is exactly
the same as the asset underlying the futures.
FRM-00, Question 17
Which statement is MOST correct?
A. A portfolio of stocks can be fully hedged by
purchasing a stock index futures contract.
B. Speculators play an important role in the futures
market by providing the liquidity that makes
hedging possible and assuming the risk that hedgers
are trying to eliminate.

C. Someone generally using futures contract for
hedging does not bear the basis risk.
D. Cross hedging involves an additional source of
basis risk because the asset being hedged is exactly
the same as the asset underlying the futures.
FRM-00, Question 79
Under which scenario is basis risk likely to exist?
A. A hedge (which was initially matched to the
maturity of the underlying) is lifted before expiration.
B. The correlation of the underlying and the hedge
vehicle is less than one and their volatilities are
unequal.

C. The underlying instrument and the hedge vehicle
are dissimilar.
D. All of the above.
FRM-00, Question 79
Under which scenario is basis risk likely to exist?
A. A hedge (which was initially matched to the
maturity of the underlying) is lifted before expiration.
B. The correlation of the underlying and the hedge
vehicle is less than one and their volatilities are
unequal.

C. The underlying instrument and the hedge vehicle
are dissimilar.
D. All of the above.
The Optimal Hedge Ratio
AS - change in $ value of the inventory
AF - change in $ value of the one futures
N - number of futures you buy/sell
F N S V A + A = A
F S F S V
N N
A A A A A
+ + =
,
2 2 2 2
2 o o o o
F S F
V
N
N
A A A
A
+ =
c
c
,
2
2
2 2 o o
o
The Optimal Hedge Ratio
F S F
V
N
N
A A A
A
+ =
c
c
,
2
2
2 2 o o
o
F
S
F S
F
F S
opt
N
A
A
A A
A
A A
= =
o
o
o
o
,
2
,
Minimum variance hedge ratio
Hedge Ratio as Regression Coefficient
The optimal amount can also be derived as the
slope coefficient of a regression As/s on Af/f:
c | o +
A
+ =
A
f
f
s
s
sf
f
s
sf
f
sf
sf
o
o
o
o
| = =
2
Optimal Hedge
One can measure the quality of the optimal
hedge ratio in terms of the amount by which
we have decreased the variance of the original
portfolio.
2
2
2
*
2
2
) (
sf
s
V s
R
o
o o
=
=
2
*
1 R
s V
=o o
If R is low the hedge is not effective!
Optimal Hedge
At the optimum the variance is
2
2
2 2
*
F
SF
S V
o
o
o o =
FRM-99, Question 66
The hedge ratio is the ratio of the size of the position taken in the
futures contract to the size of the exposure. Denote the standard
deviation of change of spot price by o
1
, the standard deviation of
change of future price by o
2
, the correlation between the changes in
spot and futures prices by . What is the optimal hedge ratio?
A. 1/o
1
/o
2

B. 1/o
2
/o
1

C. o
1
/o
2

D. o
2
/o
1

FRM-99, Question 66
The hedge ratio is the ratio of the size of the position taken in the
futures contract to the size of the exposure. Denote the standard
deviation of change of spot price by o
1
, the standard deviation of
change of future price by o
2
, the correlation between the changes in
spot and futures prices by . What is the optimal hedge ratio?
A. 1/o
1
/o
2

B. 1/o
2
/o
1

C. o
1
/o
2

D. o
2
/o
1

FRM-99, Question 66
The hedge ratio is the ratio of derivatives to a spot position (vice
versa) that achieves an objective such as minimizing or eliminating
risk. Suppose that the standard deviation of quarterly changes in the
price of a commodity is 0.57, the standard deviation of quarterly
changes in the price of a futures contract on the commodity is 0.85,
and the correlation between the two changes is 0.3876. What is the
optimal hedge ratio for a three-month contract?
A. 0.1893
B. 0.2135

C. 0.2381
D. 0.2599
FRM-99, Question 66
The hedge ratio is the ratio of derivatives to a spot position (vice
versa) that achieves an objective such as minimizing or eliminating
risk. Suppose that the standard deviation of quarterly changes in the
price of a commodity is 0.57, the standard deviation of quarterly
changes in the price of a futures contract on the commodity is 0.85,
and the correlation between the two changes is 0.3876. What is the
optimal hedge ratio for a three-month contract?
A. 0.1893
B. 0.2135

C. 0.2381
D. 0.2599
Example
Airline company needs to purchase 10,000
tons of jet fuel in 3 months. One can use
heating oil futures traded on NYMEX.
Notional for each contract is 42,000 gallons.
We need to check whether this hedge can be
efficient.
Example
Spot price of jet fuel $277/ton.
Futures price of heating oil $0.6903/gallon.
The standard deviation of jet fuel price rate of
changes over 3 months is 21.17%, that of
futures 18.59%, and the correlation is 0.8243.
Compute
The notional and standard deviation f the
unhedged fuel cost in $.
The optimal number of futures contracts to
buy/sell, rounded to the closest integer.
The standard deviation of the hedged fuel
cost in dollars.
Solution
The notional is Qs=$2,770,000, the SD in $ is
o(As/s)sQ
s
=0.2117$277 10,000 = $586,409
the SD of one futures contract is
o(Af/f)fQ
f
=0.1859$0.690342,000 = $5,390
with a futures notional
fQ
f
= $0.690342,000 = $28,993.
Solution
The cash position corresponds to a liability
(payment), hence we have to buy futures as a
protection.
|
sf
= 0.8243 0.2117/0.1859 = 0.9387
o
sf
= 0.8243 0.2117 0.1859 = 0.03244
The optimal hedge ratio is
N* = |
sf
Q
s
s/Q
f
f = 89.7, or 90 contracts.
Solution
o
2
unhedged
= ($586,409)
2
= 343,875,515,281
- o
2
SF
/ o
2
F
= -(2,605,268,452/5,390)
2

o
hedged
= $331,997
The hedge has reduced the SD from $586,409
to $331,997.
R
2
= 67.95% (= 0.8243
2
)
FRM-99, Question 67
In the early 90s, Metallgesellshaft, a German oil company, suffered a
loss of $1.33B in their hedging program. They rolled over short
dated futures to hedge long term exposure created through their long-
term fixed price contracts to sell heating oil and gasoline to their
customers. After a time, they abandoned the hedge because of large
negative cashflow. The cashflow pressure was due to the fact that
MG had to hedge its exposure by:
A. Short futures and there was a decline in oil price
B. Long futures and there was a decline in oil price

C. Short futures and there was an increase in oil price
D. Long futures and there was an increase in oil price
FRM-99, Question 67
In the early 90s, Metallgesellshaft, a German oil company, suffered a
loss of $1.33B in their hedging program. They rolled over short
dated futures to hedge long term exposure created through their long-
term fixed price contracts to sell heating oil and gasoline to their
customers. After a time, they abandoned the hedge because of large
negative cashflow. The cashflow pressure was due to the fact that
MG had to hedge its exposure by:
A. Short futures and there was a decline in oil price
B. Long futures and there was a decline in oil price

C. Short futures and there was an increase in oil price
D. Long futures and there was an increase in oil price
Duration Hedging
dy P D dP = *
Dollar duration
y F D F y S D S
F S
A = A A = A
* *
( )
( )
( )( )
2 * *
2
2
* 2
2
2
* 2
y S F SF
y F F
y S S
S D F D
F D
S D
A
A
A
=
=
=
o o
o o
o o
Duration Hedging
F D
S D
N
F
S
F
SF
= =
*
*
2
*
o
o
If we have a target duration D
V
*
we can get it by using
F D
S D V D
N
F
S V

=
*
* *
Example 1
A portfolio manager has a bond portfolio worth
$10M with a modified duration of 6.8 years, to
be hedged for 3 months. The current futures
prices is 93-02, with a notional of $100,000.
We assume that the duration can be measured
by CTD, which is 9.2 years.
Compute:
a. The notional of the futures contract
b.The number of contracts to by/sell for optimal
protection.
Example 1
The notional is:
(93+2/32)/100$100,000 =$93,062.5
The optimal number to sell is:
4 . 79
5 . 062 , 93 $ 2 . 9
000 , 000 , 10 $ 8 . 6
*
*
*
=
=
F D
S D
N
F
S
Note that DVBP of the futures is 9.2$93,0620.01%=$85
Example 2
On February 2, a corporate treasurer wants to
hedge a July 17 issue of $5M of CP with a maturity
of 180 days, leading to anticipated proceeds of
$4.52M. The September Eurodollar futures trades
at 92, and has a notional amount of $1M.
Compute
a. The current dollar value of the futures contract.
b. The number of futures to buy/sell for optimal
hedge.
Example 2
The current dollar value is given by
$10,000(100-0.25(100-92)) = $980,000
Note that duration of futures is 3 months,
since this contract refers to 3-month LIBOR.
Example 2
If Rates increase, the cost of borrowing will
be higher. We need to offset this by a gain, or
a short position in the futures. The optimal
number of contracts is:
2 . 9
000 , 980 $ 90
000 , 520 , 4 $ 180
*
*
*
=
=
F D
S D
N
F
S
Note that DVBP of the futures is 0.25$1,000,0000.01%=$25
FRM-00, Question 73
What assumptions does a duration-based hedging
scheme make about the way in which interest rates
move?
A. All interest rates change by the same amount
B. A small parallel shift in the yield curve

C. Any parallel shift in the term structure
D. Interest rates movements are highly correlated
FRM-00, Question 73
What assumptions does a duration-based hedging
scheme make about the way in which interest rates
move?
A. All interest rates change by the same amount
B. A small parallel shift in the yield curve

C. Any parallel shift in the term structure
D. Interest rates movements are highly correlated
FRM-99, Question 61
If all spot interest rates are increased by one basis
point, a value of a portfolio of swaps will increase
by $1,100. How many Eurodollar futures contracts
are needed to hedge the portfolio?
A. 44
B. 22

C. 11
D. 1100
FRM-99, Question 61
The DVBP of the portfolio is $1,100.
The DVBP of the futures is $25.
Hence the ratio is 1100/25 = 44
FRM-99, Question 109
Roughly how many 3-month LIBOR
Eurodollar futures contracts are needed to
hedge a position in a $200M, 5 year, receive
fixed swap?
A. Short 250
B. Short 3,200

C. Short 40,000
D. Long 250
FRM-99, Question 109
The dollar duration of a 5-year 6% par bond is
about 4.3 years. Hence the DVBP of the fixed
leg is about
$200M4.30.01%=$86,000.
The floating leg has short duration - small
impact decreasing the DVBP of the fixed leg.
DVBP of futures is $25.
Hence the ratio is 86,000/25 = 3,440. Answer A
Beta Hedging
| represents the systematic risk, o - the
intercept (not a source of risk) and c - residual.
it mt i i it
R R c | o + + =
M
M
S
S A
~
A
|
A stock index futures contract
M
M
F
F A
~
A
1
Beta Hedging
M
M
NF
M
M
S F N S V
A
+
A
= A + A = A |
The optimal N is
F
S
N
|
= *
The optimal hedge with a stock index futures
is given by beta of the cash position times its
value divided by the notional of the futures
contract.
Example
A portfolio manager holds a stock portfolio
worth $10M, with a beta of 1.5 relative to
S&P500. The current S&P index futures price
is 1400, with a multiplier of $250.
Compute:
a. The notional of the futures contract
b. The optimal number of contracts for hedge.
Example
The notional of the futures contract is
$2501,400 = $350,000
The optimal number of contracts for hedge is
9 . 42
000 , 350 $ 1
000 , 000 , 10 $ 5 . 1
* =
=
F
S
N
|
The quality of the hedge will depend on the
size of the residual risk in the portfolio.
A typical US stock has correlation of 50% with S&P.
Using the regression effectiveness we find that the
volatility of the hedged portfolio is still about
(1-0.5
2
)
0.5
= 87% of the unhedged volatility for a
typical stock.

If we wish to hedge an industry index with S&P
futures, the correlation is about 75% and the
unhedged volatility is 66% of its original level.

The lower number shows that stock market hedging
is more effective for diversified portfolios.
FRM-00, Question 93
A fund manages an equity portfolio worth $50M
with a beta of 1.8. Assume that there exists an
index call option contract with a delta of 0.623 and
a value of $0.5M. How many options contracts are
needed to hedge the portfolio?
A. 169
B. 289

C. 306
D. 321
FRM-00, Question 93
The optimal hedge ratio is
N = -1.8$50,000,000/(0.623$500,000)=289

FRMJorion 14 Hedging Linear Risk

Enviado por

Dados do documento

Descrição original:

Título original

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

FRMJorion 14 Hedging Linear Risk

Enviado por

Direitos autorais:

Formatos disponíveis

http://pluto.huji.ac.il/~mswiener/zvi.

Você também pode gostar