Hedging Strategies using Futures (FRM Part 1 2023 – Book 3 – Chapter 6)

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After completing this reading, you should be able to:
- Define and differentiate between short and long hedges and identify their appropriate uses.
- Describe the arguments for and against hedging and the potential impact of hedging on firm profitability.
- Define the basis and explain the various sources of basis risk, and explain how basis risks arise when hedging with futures.
- Define cross hedging, and compute and interpret the minimum variance hedge ratio and hedge effectiveness.
- Compute the optimal number of futures contracts needed to hedge an exposure, and explain and calculate the “tailing the hedge” adjustment.
- Explain how to use stock index futures contracts to change a stock portfolio’s beta.
- Explain the term “rolling the hedge forward” and describe some of the risks that arise from this strategy.

0:00 Introduction
0:27 Learning Objectives
1:19 Short Hedges vs. Long Hedges
5:13 Advantages and Disadvantages of Hedging
6:53 Basis Risk and Its Causes
10:10 Cross Hedging
13:03 The Optimal Hedge Ratio
16:37 The Optimal Number of Futures Contracts Needed to Hedge an Exposure
17:36 Adjusting a Stock Portfolio's Beta using Stock Index Futures
23:23 Rolling Hedge
24:07 Book 3 - Financial Markets and Products Chapter 6