Derivatives

Perry Urena

012803971

Fin 480

8/29/2016

1. Under what risk does basis risk become relevant in futures trading?

Basis risk= (Hedged asset spot price – Futures Price of contract used. This becomes relevant because its overall futures risk, so to minimize risk, means strengthening the basis; therefore increasing the basis. Investing is all about minimizing risk.

1. How to use future contracts to fix the price value of your spot asset?

You contract to buy a good at a now for its projected future price and make (save) on because the price rises in the future, but you don’t actually pay until the time comes. So you end up with goods less than market value.

1. Under what circumstances would it make sense to talk about optimal number of future contracts for hedging purposes?

Hedging comes into play to minimize risk. To determine the optimal units to include in the futures contract, you use the hedging ratio which is the standard deviation rate of change of the spot and futures price times the ratio of the size of units being hedged/the total units of one contact. It creates the necessary quantity of units to hedge to stay safe.

1. How do we hedge the value of your equity portfolio using index futures contracts?

You divide the current value of the portfolio by the current value of the futures contract size. Optimization is at 1.0. You apply the CAPM of Beta(Return on index-Risk free interest rate)

1. What would you do to realign your current portfolio beta value to your target beta value?

You divide the current beta by the target beta, then you take that number and multiply it to the value of the portfolio; this synchronizes the beta to the portfolio.