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Hedging an Equity Portfolio - Essay Example
Derivatives traded on exchange markets that may include currency futures and options and swaps are usually limited. Moreover, the foreign market activities have a vulnerability of being highly hindered by the presence of exchange controls and other regulations…
Cross hedging capabilities may depend on various factors. First is the degree in which the spot and futures currencies are negatively or positively correlated. Secondly, this also depends on the level of accuracy of the estimated risk-minimizing cross-hedge factors. In addition, time is an important factor in this process and therefore the capability of cross hedging depends on the stability of the optimal cross hedge proportions over a given duration or period of time. Moreover, this also depends on the potential risk reduction from portfolio cross-hedging. A hedger is any individual or institution that minimizes the variance of expected monetary returns on a currency spot position with regards to a position in the currency’s corresponding future contract. There are various reasons for hedging in a financial set up. First is for the purposes of managing volatility in cash flows. Secondly, hedging is important for the purposes of checking the market value of an organization’s shares. Hedging is also used for the purposes of managing volatility in accounting earnings. In addition, the management of balance sheet accounts and ratios can also benefit from hedging.