7 Reference: 9 1.0 Introduction A US equity fund manager holds €100m in a portfolio comprising the largest US stocks which perfectly replicates and benchmarks the S&P 500 index. The US Federal Reserve indicated that the programmed quantitative easing of purchasing $85 billion is not going to be carried out. The quantitative easing is used to stimulate the price when the corresponding interest rate decreases to 0%. The non execution of the quantitative easing is set to correct the equity market. The fund manager predicts that the reluctance of the US Federal Reserve to perform a quantitative easing is going have a profound effect on the performance of the portfolio. For this reason the fund manager as such wants to hedge the portfolio using option instead of futures. 2.0 Advantages and disadvantages of using options to hedge this scenario compared to using futures only Fund managers use both futures and options to order to hedge their portfolio. Though there are some marked differences in the two types of hedging tools. The choices of the hedging tools depend on the fund manager as well as the objective to hedge. In the present scenario, the fund manager has decided to use the options instead of futures (Reilly and Brown, 2000). This is because of the reason that the options provide certain leverage in comparison to futures. The most basic advantage is that an option gives the option holder the right and not an obligation. In case of the futures both the parties have equal obligations. The second advantage is that the amount of loss is limited to the buyer of option while in futures the losses can be unlimited. Option and future both provides same opportunity to the holder to minimize loss and at same time make profit. The US Federal Reserve has decided to stop quantitative easing. The quantitative easing techniques are supposed to create a stimulant which helps to ease the pressure on prices of funds. The price decreases when the interest falls or drops sharply. The sharp drop of interest is associated with a corresponding decrease in the price level. This means if the fund manager wants to invest in various funds, then the increase in the price of the various funds will limit the ability of the fund manager to invest effectively (Hearth and Zaima, 1998). The fund manager is not sure what will happen in the future but the non execution of the quantitative easing program indicates that the fund manager can only invest in limited fund with the present value of the equity portfolio, since the price of the funds have increased. If the fund manager anticipates that the share price will increase then he can buy a future. The sudden growth in the share price of equity may not find enough buyers. The problem with buying a future contract is that if the price of the funds drop then the fund manager is obliged to sell the future at the decreased price. So the future holder is in a risk, if the anticipated increase in price does not take place and instead of that the price actually decreases. So on one hand there is chance to make profit while on the other hand there is chance to incur loss. There are no restrictions to the limit of profit or loss. This is one of the greatest disadvantages of using the future contract. The advantage of the options with respect to future can be explained with the help of an example. As already explained the find manager is anticipating in increase in the p
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Hedging an Equity Portfolio Using Options Table of Contents Table of Contents 2 1.0 Introduction 3 2.0 Advantages and disadvantages of using options to hedge this scenario compared to using futures only 3 3.0 Explanation of how options could be used to hedge the risk faced by the fund manager 5 4…
Beta is used to measure risk. A stocks beta indicates the sensitivity of the stock’s returns to the market returns (Madura 2006, p. 304). Madura (2006, p. 304) states that investors who have a diversified portfolio use beta to determine how well their portfolio reflects movements in the market.
Similarly, pension funds as well as insurance companies utilize modeling in identification of assets for their respective portfolios. Private equity funds, just like other sectors also use models to evaluate their effectiveness and performance. The widespread use shows the effectiveness of modeling as an integral part in analysis.
Secondly, Virtual Books are going to engage in import of certain products from Slovakia which will trigger a cash outflow in Euros. However in this case, the company must use its GBP account to effect the payment. Hence in both cases, Virtual Books has an exposure to potential exchange rate risk.
The very basics of economics states that the prices of goods and services depend on the forces of demand and supply. When the demand for goods and services increases the prices are expected to increase in future and vice-versa. But in the competitive market where there are many participants, especially in a globalised world, possible rise of production cost could adversely affect production margins if the companies are not able to pass on the higher cost of production to their customers in fear losing them to rivals.
Stein or his Board of Directors on this report.
Portfolio management is the process of combining securities in a portfolio tailored to the investor's preferences and needs, monitoring that portfolio, and evaluating its performance. Investor portfolios are composed of diverse types of assets.
This literature review would examine the theoretical and conceptual constructs of currency hedging strategies and their relevance or irrelevance to all firms in a highly competitive and risk prone money market.
In the first instance currency hedging practices have their relative individual significance vis--vis non-currency investment opportunities and net returns on such investment vehicles (Zarin, & Zimmerman, 2006).
By exploring how risk-averse investors can construct optimal portfolios through consideration of the trade-off between market risk and expected returns, Markowitz presents the benefits of diversification. Out of a variety of risky investments, an investor can compile an effective portfolio of investments, each of which will offer the maximum possible expected return for a given level of risk.
ted risk thus minimizing the level of risk associated with such developments like inflation, changes in interest rates and exchange rate volatility (Hsin, Kuo, & Lee, 1994). This literature review would examine the theoretical and conceptual constructs of currency hedging