Futures Price Calculation and Contract Selection Quiz

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In cross hedging, why is it important to choose a futures contract that is highly correlated with the asset being hedged?

To guarantee a fixed exchange rate

To reduce the risk of imperfect correlation affecting the hedge effectiveness (correct)

To eliminate any risk of loss

To ensure a perfect relation between the two assets

What does the hedge ratio help in estimating?

The future price of the asset

The amount of risk to be assumed in the hedge

The optimal position to take in the futures market

The quantity of futures contracts needed for an effective hedge (correct)

Why is locking in a specific exchange rate challenging in a futures contract?

Due to the constantly changing spot price

Since the spot price is always lower than the future price

Because of the requirement for a non-zero basis (correct)

Because futures contracts have fixed rates

What is the purpose of using a delivery month close to, but after, the life of a hedge?

To effectively manage price risk Signup and view all the answers

What is the most likely reason for using heating oil futures to hedge jet fuel purchases by an airline?

High correlation between heating oil prices and jet fuel prices Signup and view all the answers

Why is it important for the futures price to be highly correlated with the asset price when cross hedging?

To reduce basis risk and improve hedging effectiveness Signup and view all the answers

What does basis risk refer to in the context of hedging?

The risk arising from not finding a perfect hedge due to various uncertainties. Signup and view all the answers

Why might a hedger require the future contract to be closed out before the delivery month?

Because of uncertainty about the exact date of buying or selling the asset. Signup and view all the answers

How does minimizing basis risk help in hedging strategies?

Improves the correlation between spot position and futures contract. Signup and view all the answers

What is the basis typically defined as in hedging?

The difference between the spot price and the futures price. Signup and view all the answers

How does selecting a futures contract with a closer maturity to the hedging horizon help in reducing basis risk?

It helps align the maturity of the futures contract with the hedging duration. Signup and view all the answers

In what situation might a hedger face challenges in finding a perfect hedge?

When there are uncertainties about future asset delivery dates and types of assets. Signup and view all the answers

What is the value of the portfolio mentioned in the text?

$5 million Signup and view all the answers

How many futures contracts on the S&P 500 are needed to hedge the portfolio in the example provided?

30 contracts Signup and view all the answers

Why might someone want to hedge equity returns according to the text?

To ensure a risk-free return plus excess return over the market Signup and view all the answers

In the context of hedging, what does beta measure?

The sensitivity of the portfolio to market movements Signup and view all the answers

Based on the text, which futures contract related to the S&P 500 index is considered in the example?

$250 times the index Signup and view all the answers

What is the hedge ratio mentioned in the text for the portfolio with a beta of 1.5?

$30 contracts Signup and view all the answers

Futures Price Calculation and Contract Selection Quiz

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