Financial Modelling 2557A/B Lecture Notes - Lecture 7: Bear Spread, Bull Spread, Basis Risk
17 Apr 2017
School
Department
Professor
Document Summary
Firm is profitable if proceed of what it produces > cost of its inputs. If price of commodity is unstable, firm"s profitability will be affected o. For producer selling risky commodity, profit decreases when price of commodity decreases. For buyer using risky commodity as input, profit decreases when price of commodity increases. Risk management: actively using derivatives and other techniques to alter risk and protect profitability. If in inherent long position, should use strategy that provides benefit when price of underlying declines. Short forward, long put, purchased collar, bear spread. If in inherent short position, should use strategy that provides benefit when price of underlying increases. Long forward, long call, bull spread, written collar. Perfect hedge: hedger can offset exactly the risk faced in the market by taking an equivalent but opposite position in the futures market. Must find futures contract that can match exactly 2 things: asset to be delivered, maturity date, amount.
