## HEDGING BY FUTURES

### 1.Hedging the Cost of Funds

Cash Market / Futures Market
17 August
A company expects to borrow approximately \$1 million in two months. The current rate of interest is 13.5% p.a., and is expected to rise.
(Value of bank bill = \$967,784.70) / 17 August
Sell one (\$1 million) December 90-day bank bill futures contract at 86.50; yield of 13.50% p.a.
(Value of futures contract = \$967,784.70)
17 October
Draw bill with a face value of \$1 million at 15.00% p.a.
(Value of bank bill = \$964,332.89)
Additional cost of borrowing on 17 October compared with borrowing on 17 August
= \$3,451.81 / 17 October
Buy a December 90-day bank bill futures contract at 85.00 and thus close out futures market position.
(Value of futures contract = \$964,332.89)
Profit from closing out of the futures contract
= \$3,451.81

### 2.Hedging the Rate of Return

Cash Market / Futures Market
17 October
A company expects to have funds in 3 months time that will enable it to buy \$1 million bank bills; current yield is 11.75% p.a.
(Price of bank bill, if bought today
= \$971, 843.17) / 17 October
Buy a March bank bill futures contract at 88.25; yield of 11.75% p.a.
(Value of futures contract = \$971,843.17)
17 January
The company buys a 90-day \$1 million bank bill at current yield of 10.50% p.a.
(Price of bank bill = \$974,762.98)
Fall in yields of 1.25% p.a. over period; additional cost of bill = \$2,919.81 / 17 January
Sell a March 90-day bank bill futures contract at 89.50.
(Value of futures contract = \$974,762.98)
Profit from closing out of the futures contract
= \$2,919.81 used to offset lower money market return

Note:

• Value of bank bill =

### 3.Hedging the Cost of Foreign Currency

Cash Market / Futures Market
12 July
Australian importer buys US goods at a cost of USD80,000 and agrees to pay in USD on 12 November; spot AUD/USD 0.8000.
(Spot Cost = AUD100,000) / 12 July
Sell one AUD December futures contract at 0.8000.
(Face value of contract = AUD100,000)
(Value of contract = USD80,000)
12 November
Spot AUD/USD 0.7750. Importer pays USD80,000 at a cost of AUD103,225.80.
(Additional cost compared with cost on 12 July = AUD3,225.80) / 12 November
Close out futures position by buying one AUD December contract at 0.7750.
(Value of futures contract = USD77,500)
(Profit from closing out of the futures position is USD2,500; AUD value is 2,500/0.7750 = AUD3,225,80)

### 4.Hedging the Value of a Share Portfolio

#### Cash Market

/ Futures Market
12 July
A fund has diversified portfolio with a current market value of \$41 million (the all Ordinaries index is at 1,500, but is expected to fall) / 12 July
Sell 1,093 December All Ordinaries share price index futures contracts at 1,500.
Contract value = 1,093 x 1,500 x \$25 = \$40,987,500
1 November
The All Ordinaries index now stands at 1,400, and is thought to be ready to rise again; the fund’s portfolio has fallen in value in line with the share market.
% fall in the market = 6.67%
Value of portfolio = \$38,265,300
Loss in portfolio value = \$2,734,700 / 1 November
Close out futures market position; buy 1,093 December contracts at 1,400
Contract value = 1,093 x 1,400 x \$25
= \$38,255,000
Profit from close out = \$2,732,500
Net loss = \$2,200

Note:

• The dollar value of one All Ordinaries share price index futures contract is 25 times the physical market index.

(Extracted from Australian text “Financial Institutions, Instruments and Market” 3rd edition, p.510)