Question
Assume hedger takes hedge ratio as h* , i.e, if the risk exposure is a long position of 100 units of spot commodity, to hedge
Assume hedger takes hedge ratio as h*, i.e, if the risk exposure is a long position of 100 units of spot commodity, to hedge the risk, hedger will short 100h* futures underlying on that commodity. Please answer the questions in the right panel in analogy to the left panel, by filling the blanks in j) -r) below
*left panel*
If the stock price falls from 3 to 2, then
a)the future price falls from 3 to 2;
b)hedger makes profit (3-2)100h*=100h* from the future, at t=1;
c)by investing the profit from t=1 till t=2, 100h* dollars profit becomes (1+0.1)100h*=110 h*;
d)meanwhile, hedger makes a loss of 100(2-3)= -100 from the stock at t=1;
e)hedger doesn't make further loss on stock from t=1 to t=2;
f)net profit/loss is [110h*-100] dollars;
g)stock price is 2 at t=2, hence the value of stock at t=2 is 2100=200;
h)the value of futures is its gain and loss, hence, at t=2,its value is 110h*;
i)the value of the portfolio is the sum of the value of stock and the value of futures, which is [200+110h*].
*right panel*
If the stock price rises from 3 to 4, then
j)the future price____________________;
k)hedger makes_________________from the future, at t=1;
l)___________________from t=1 till t=2, _______________becomes_______________________________;
m)meanwhile, hedger makes a profit _______________from the stock at t=1;
n)hedger doesn't make further _____________on stock from t=1 to t=2;
o)net profit/loss is___________________;
p)stock price is_____ at t=2, hence the value of stock at t=2 is______________;
q)the value of futures is its gain and loss, hence, at t=2,its value is____________;
r)the value of the portfolio is the sum of the value of stock and the value of futures, which is___________________.
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