Beruflich Dokumente
Kultur Dokumente
By Vaibhav Kabra
M.F.S.M, F.R.M.
Short Sales
In order to execute a short sale the following has to be done by the short seller
Borrow and sell securities simultaneously through the broker The short seller has to return the securities when demanded by the lender/broker or when the short sale is closed out A deposit is kept with the broker
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Short Squeeze
Short Squeeze Whenever the lender/broker runs out of securities to lend, the short seller is forced to close his position, this situation is short squeeze
Deposit collateral with lender to guarantee the eventual repurchase of the security
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Forwards Valuation
Pricing Model: Assumptions 1. Borrowing and lending at risk free rate 2. Same tax rates on all net profits 3. No transaction costs
Forwards Valuation
The equation for forward price of an asset paying no dividend is given by
F0 = S0 * erT
An arbitrage opportunity will arise if the above equation does not hold true For e.g. If F0 > S0 * erT , then one would profit by selling the forward and buying the asset with the borrowed funds If F0 < S0 * erT , then one would profit by selling the asset, lending out the proceeds and buying the forward
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Forwards Valuation
Impact of Interim Cash Flows on Forward Prices
(Benefit to the Owner of Stock/Commodity)
If the underlying pays a known amount of cash over the life of the forward contract, the equation for the forward price becomes
Forwards Valuation
Impact of Dividends on Forward Prices
(Benefit to the Owner of Stock/Commodity)
When the underlying asset for a forward contract pays a dividend, the equation for Forward Price is
F0 = S0 * e(r-q)T
q is the continuously compounded dividend yield
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Forwards Valuation
Impact of Lease Rates on Forward Prices
(Benefit to the Owner of Stock/Commodity)
Lease Rate is the amount of interest a commodity lender requires The lease rate signifies the amount of return that an investor requires after buying and then lending the commodity A commodity lender can earn the lease rate by buying a commodity and immediately selling it forward. Now the forward price when the lease rate comes in the picture is
F0 = S0 e ( r )T
where = lease rate
The lease rate is the income earned if and only if the commodity is loaned out
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Forwards Valuation
Impact of Storage Costs on Forward Prices
(Cost to the Owner of Stock/Commodity)
Holding a commodity requires storage costs. Hence the forward price must be greater than the spot price to compensate for the physical storage costs. The owner will only hold the commodity if the forward price is greater than or equal to the expected spot price plus storage costs.
F0 = S0 * e(r+)T
is the continuous annual storage cost
Forwards Valuation
Impact of Convenience Yield on Forward Prices
(Benefit to the Owner of Stock/Commodity)
If the owners of the commodity need the commodity for their business, holding a physical inventory of the commodity creates value. For example, assume a manufacturer requires a specific commodity as a raw material. To reduce the risk of running out of inventory and slowing down production, excess inventory is held by the manufacturer. This reduces the risk of idle machines and workers. In the event that the excess inventory is not needed, it can always be sold. Holding an excess amount of a commodity for a non monetary return is referred to as convenience yield
c is the continuous compounded continuous yield
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F0 = S0 * e(r-c)T
Forwards Valuation
Comparing Lease Rates, Storage Costs and Convenience Yield.
F0 = S0 * erT
This expression says that if there are no cost or benefits associated with buying and holding the commodity, the forward price is just the spot price compounded at the risk free rate over the holding period . If there are benefits (e.g.: lease rates , convenience yield ) to buying the commodity today , the holder is willing to accept a lower forward price . The forward price is reduced by the benefit
F0 = S0 e ( r )T F0 = S0 * e(r-c)T
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Forwards Valuation
Comparing Lease Rates, Storage Costs and Convenience Yield.
If there are costs such as storage costs associated with the purchasing of commodity today the forward price is increased by the cost
F0 = S0 * e(r+)T
If costs and benefits are combined the equation for forward price becomes
F0 = S0 * e(r-c- +)T
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Concept Checker
Calculate the 9 month forward rate for a bushel of Corn that has a spot rate of $10 and an annual lease rate of 6%. The appropriate continuously compounding annual risk free rate for the commodity is equivalent to 9%.
A. B. C. D.
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Concept Checker
Suppose the spot price today for a bushel of corn is $4 , the continuously compounded interest rate is 8% , and the monthly storage costs are 3.5% .Calculate the 9 month forward price. 4.26 5.5 3.5 2
A. B. C. D.
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Concept Checker
Calculate the 3 month forward price for a bushel of soybeans if the current spot price is $3 per bushel , the effective monthly interest rate is 1% , and the monthly storage costs are $ 0.04 per bushel.
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Commodity Spread
A commodity spread occurs when a commodity is an input in the production of other commodity Example: Crush Spread Soybean used in production of soybean oil Hold long (short) position in soybean and short (long) position in soybean oil This is called crush Spread Example : Crack Spread Crude oil , heating oil & gasoline Crack spread : 7-4-3 spread : 7 gallons Crude oil , 4 gallons heating oil & 3 gallons gasoline Thus an oil company can lock in crude oil input and output (finished goods) price
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Commodity Spread
Suppose we plan on buying crude oil in 1 month to produce gasoline and hitting oil for sale in 2 months . The one month future price for crude oil is currently $42.5 per barrel. The 2 month future price for gasoline and heating oil are $45 per barrel and $43.5 per barrel respectively . What is the 7-5-2 crack (commodity) spread. 2.07/barrel 6/barrel 14.5/barrel 22.09/barrel
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A. B. C. D.
Short Hedge
This occurs when the hedger shorts the future contract This strategy is employed when the hedger is currently in a long position and wants to hedge against price decrease
A short hedge is appropriate when the hedger already owns an asset and expects to sell it at some time in the future.
Example : A wheat producer sells wheat futures to lock in the price today and hedge against price decrease
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Long Hedge
This occurs when the hedger buys the future contract This strategy is employed when the hedger is currently in a short position and wants to hedge against price increase
A long hedge is also appropriate when the hedger expects to buy it at some time in the future.
Example : A wheat whole seller buys wheat futures to lock in the price today and hedge against price increase
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Basis Risk
A perfect hedge occurs when the characteristics of the hedged asset and the futures contract (the hedging instrument ) perfectly match. When this is the case the gains on the futures position and the losses on the hedged asset cancel each other. However this is not always the case. When the characteristics of the hedged asset and the hedging instrument do not match due to different underlying assets used or different maturities of the assets, it may lead to Basis Risk.
Present
Time Maturity
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Basis Risk
Basis = Spot Price (Hedged Asset) - Futures Price (Hedging Instrument) The change in the basis is unavoidable. The change in basis over the hedge horizon is termed basis risk, and it can work either for or against the hedger
The basis will be zero at maturity if the Hedged asset and the asset underlying the hedging instrument are the same
When the spot price increase at a faster rate than the futures price, the basis increases and it is referred to as Strengthening of Basis When the Futures price increase at a faster rate than the Spot price, the basis decrease and it is referred to as Weakening of Basis
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S,F = the correlation between the spot prices and the futures prices S = the standard deviation of the spot price F = the standard deviation of the futures price
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Concept Checkers
A fund manager has a $100 million portfolio with a beta of 0.75 . The manager has bullish expectations for the next couple of months and plans to use futures contract on the S&P 500 to increase the portfolios beta to 1.8 . Given the following information, which strategy should the fund manager follow :
A. B. C. D.
The current level of the S&P index is 1250 Each S&P futures contract delivers $250 times the index The risk free interest rate is 6% p.a.
Enter into a long position of 323 S&P futures contract Enter into a long position of 336 S&P futures contract Enter into a long position of 480 S&P futures contract Enter into a short position of 240 S&P futures contract
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Concept Checkers
A company expects to buy 1million barrels of West Texas intermediate crude oil in 1 year . The annualized volatility of the price of a barrel of WTI is calculated at 12 % . The company chooses to hedge by buying a futures contract on Brent Crude . The annualized volatility of the Brent Futures is 17% and the correlation co efficient is 0.68 .
Calculate the variance minimizing hedge ratio A. 0.62 B. 0.53 C. 0.48 D. 0.42
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Concept Checkers
Consider an equity portfolio with market value of $100 million and a beta of 1.5 with respect to the S&P 500 index. The current S&P 500 index level is 1000 and each futures contract is for delivery of $250 times the index level . Which of the following strategy will reduce the beta of the equity portfolio to 0.8 Long 600 S&P 500 futures contract Short 600 S&P 500 futures contract Long 280 S&P 500 futures contract Short 280 S&P 500 futures contract
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A. B. C. D.
Thank You !