Hedging

Jayendra Salunke
EMBA - ITM Kharghar
Batch XIII-B, Roll no 70
 This Session Covers
What is Hedging - Concept
Hedging Instruments Examples
Hedge funds
History
Hedge Funds today
Five famous Hedge Funds
 Hedging - Concept
Used everywhere all time - Story
Negative event can not be prevented
Risk Offsetting tool
Similar to insurance
Two securities with Negative correlation
Not to make money but to reduce losses
 How do investors Hedge ?
Hedging instruments
Derivatives
Forward Contracts
Future Contracts
Options
Put option
Call option
Swaps
 Forward Contract
It is an agreement to buy or sell an asset at a certain future time for certain price.

Shyam wants to buy a TV - Rs 10,000 - no cash - Can buy it 3 months later -

fears that prices will rise - contract with the dealer - contract is settled at maturity.

Ram - importer - has to make a payment in dollars for consignment in six months
time -not sure what the Re/$ rate then - contract with a bank to buy dollars six
months from now at a decided rate - underlying security is the foreign currency.

The difference between a share and derivative is that shares/securities is an asset

while derivative instrument is a contract
 Future Contract
A future contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price. Index futures are all futures contracts
where the underlying is the stock index and helps trader to take a view on the
market as a whole.
Example - An automobile mfr - huge quantities of steel as raw material - export
contract - risk of increasing steel prices - buy steel futures contracts, - the
automobile manufacturer is protected.

Increasing steel prices - Increase in the value of the futures contracts -

corresponding loss in the physical market - offset by his gains in the futures market.
Decreasing steel prices - Decrease in the value of the futures contracts - losses in
the futures transaction - corresponding gain in the physical market .

Perfect hedge to lock the profits and protect from increase or decrease in raw
material prices.
 Call Option
An option is a contract between two parties giving the taker (buyer) the right, but
not the obligation, to buy or sell a parcel of shares at a predetermined price
possibly on, or before a predetermined date. To acquire this right the taker pays a
premium to the writer (seller) of the contract.

Sam purchases a December call option at Rs 40 for a premium of Rs 15. That is he

has purchased the right to buy that share for Rs 40 in December. If the stock rises
above Rs 55 (40+15) he will break even and he will start making a profit. Suppose
the stock does not rise and instead falls he will choose not to exercise the option
and forego the premium of Rs 15 and thus limiting his loss to Rs 15.
Call Option
 Put Option
A Put Option gives the holder of the right to sell a specific number of shares of an
agreed security at a fixed price for a period of time.

Saif purchases 1 00 shares of Beximco in August 3500 Put --Premium 200

This contract allows Sam to sell 100 shares of Beximco at Tk 3500 per share at any
time between the current date and the end of August. To have this privilege, Sam
pays a premium of Rs 20,000 (Rs 200 a share for 100 shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the
right to sell.
 Hedge Funds
Alfred Jones Father of Hedge fund
First Money Manager
Rise of Industry 1968 140 Hedge funds
1969-70 Heavy Losses - 1973-74 No of hedge fund closures
1986 tiger Fund - 1999- 2000 history repeats
The Down side
What Hedging means to you
Five famous Hedge Funds
Goldman Sachs
Long Term Capital Management
Man Group
Soros Fund Management
Thank You