28 Nov
Hedging Through Index Futures | CA Final SFM
What are Index Futures?
Index futures are futures contracts on a stock market index. These are future contracts where the underlying is a specific index of a specific stock market. As one cannot physically buy or sell an index, the index futures are always settled in cash.
How to hedge risk of a stock using Index Futures?
In order to hedge a portfolio of stock with Long Position, the investor has to enter into index future contract with a short position. As long as the contract for index future matures, the stock will be hedged. The following procedure will be required:
Step 1
Determine the value of stock portfolio at present, i.e.,
= Number of Shares X Spot Price per Share
Step 2
Determine the beta of Stock with Index
Step 3
Determine the desired value of Index Future Portfolio
Or
For creating a Perfect Hedge, the Hedge Ratio must be equal to beta. Therefore,
Step 4
Determine the number of Index Futures to be contracted.
Step 5
Determine the outcome of the scenario based on given information.
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