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Cross Hedging

Cross Hedging. R. Srinivasan. Question 1.

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Cross Hedging

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  1. Cross Hedging R. Srinivasan

  2. Question 1 • It is 20th June, and a Pension fund wishes to hedge Rs.1 mn stock. The hedge period is of 5 months. Portfolio  = 1.5. The dividend yield on the equity portfolio = 4% p.a. Choose to hedge with December futures contract with t = ½. The current level of Index is at 6400 spot and the futures contracts trade at Rs.10 per index point. How many contracts you will short to hedge your position. Let rf = 10%.

  3. Solution

  4. Question 3 • Let NIFTY be at 1000 points, value of your portfolio be 5.05 mn, rf= 4%, dividend yield on the Index = 1%, and  of Portfolio = 1.5. Assume that the futures contract on the index with 4 months maturity is used over the next 3 months. Let F1 = 1010. What is the expected return on the portfolio, if NIFTY comes out to be 900 in Dec and the futures price in Dec works out to be F2 = 902. Show the expected value of hedger’s position including gain on the hedge.

  5. Solution • E(rm) = (1000 – 900) / 1000 = – 10% • E(rm) = – 10% + 0.25% = – 9.75% • E(rp) = rf + 1.5 x (-9.75 – 1) = – 15.125% • Therefore, the expected portfolio value = 5050000 ( 1 – 0.15125) = 4286188 • Gain on hedge = 30 x (1010 – 902) x 250 = 810000 • Hedger’s total gain = = 4286188 + 810000 = 5096188 • Hedger’s return = (5096188 – 5050000) / 5050000 = 46188 / 5050000 = 0.91%  1% = rf • The hedger gains rf rate due to hedging.

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