Question of the hedge ratio for futures contracts.

Discussion in 'P1.T3. Financial Markets & Products (30%)' started by FRMStrawberry, May 12, 2012.

  1. FRMStrawberry

    FRMStrawberry Member

    In the manual David preparted for markets and products part, on P27,
    1. when Beta is 1.2, N*=32, it says that need to short 32 futures contracts.
    2. Beta becomes Beta* and increases from 1.2 to 2, the optimal number of contracts is N=21.33, then long poistion on 21.33 futures contracts.
    I couldn't understand why in 1., the positin is short, while in 2., the position is long.
    I think that both of them should be in long position as both of N* and N are have "+" sign.
    Please help me understand this.

  2. jeff-1984

    jeff-1984 Member

    I was gonna ask the same question but then I saw this topic
    In the notes, it says that it depends on the sign "-" means shorting and ''+" means going long but that wasnt the case in the PQ! is there another logic here that we should follow ? I came across a question which had the word increase so i understood its about going long but sometimes there's no clue !!
    Please David or anyone else, can you clarify this ?
  3. David Harper CFA FRM

    David Harper CFA FRM David Harper CFA FRM (test) Staff Member

    Hi FRMStraberry & Jeff,

    I am following Hull. If we want to rely on the signs (+/-), we can use the general form: (target beta - current beta) * V(P)/V(F) = (B* - B)*V(P)/V(F).
    • So, if we are increasing the beta from 1.2 to 2.0, it implies a LONG position because (target 2.0 - 1.2) = positive.
    • On the other hand, if we are NEUTRALIZING beta (i.e., "hedging") then our target beta is zero and this implies a SHORT position because (target 0 - 1.2) = negative; i.e., to "hedge" in many cases, means to neutralize so we can use target beta = 0.

      (Hull actually has use-cases for each, which is even more confusing, I think ...)
    Although i feel it's a little risk to rely on signs for this. I personally think it's a little more robust to compute number of contracts, then use intuition to retrieve a long or a short. I hope that helps, thanks,
    • Like Like x 1

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