H1 Hedging with Futures

A portfolio manager holds an equity basket and hedges it with an index future over two periods.

Objective

Hedge the basket against a fall in the market. Assessed on profit and loss.

What it shows

• Hedging a portfolio with an index future.
• Hedge ratio: how many futures offset a basket that is not the index.
• The hedge that leaves basis risk.

Watch out for

• Hedging one for one when the basket moves differently from the index.
• Selling the future and not noticing the hedge has made the position a bet on the basis.
• Two periods, so the hedge has to be kept.

Who takes part

• Portfolio manager — every student. Holds 5,000 EQTY, an equity basket, and trades IDX, the market index, and IDXF, a future on it.

Class size

Ten to forty students in one role.