1. Mitigating Risk: Hedging
with Forwards and Futures in
Financial Markets
Group-8
Ashana Shirodkar-103
Jinal Patel-72
Rutuja Rane-90
Prathamesh Rane-89
Mayank Tyagi-111
Krishna Parab-70
2. What does Hedging mean ?
Hedging is a risk management strategy used
to minimize potential losses or offset the
impact of adverse price movements in
financial markets. It involves taking a
position in a financial instrument (like a
contract or derivative) that acts as a
counterbalance to an existing or anticipated
exposure.
3. Hedging with Forwards- Foreign
Exchange Market
Consider an Indian company that plans to import machinery
from the United States and will need to pay in U.S. dollars in
six months. The company is concerned about the potential
appreciation of the U.S. dollar against the Indian rupee,
which could increase the cost of the machinery. To hedge
against this risk, the company enters into a forward contract
to buy U.S. dollars and sell an equivalent amount in Indian
rupees at a specified exchange rate for the date of payment.
This forward contract helps the company secure a known
exchange rate and mitigate the risk of unfavorable currency
movements.
4. Hedging with Forwards- Commodity
Market
Imagine an Indian tea producer who expects to harvest
and sell a certain amount of tea in nine months. The tea
producer is concerned about the possibility of a decline
in tea prices due to oversupply or changing market
conditions. To protect against potential price decreases,
the producer enters into a forward contract to sell the
tea at a predetermined price. By doing so, the producer
can lock in a selling price and mitigate the risk of a
price drop in the tea market, ensuring a more
predictable revenue for their tea crop.
5. Hedging with Futures- Secondary Market
An investor holds 1000 shares of XYZ Ltd. at
₹150 per share and anticipates a potential
price drop. To hedge against this, they enter
a futures contract for XYZ Ltd. at ₹148 per
share, selling 10 futures contracts.(100qty
in 1 lot) If XYZ Ltd.'s stock price falls, gains
from the futures contract offset losses in the
stock, providing a hedge. If the stock price
rises, any losses in futures act as insurance
against the potential downturn.
6. Hedging with Futures- Portfolio
Management
An Indian investor manages a ₹1 crore diversified
stock portfolio and anticipates market volatility. To
protect against potential losses, they opt to hedge
50% of the portfolio's value using Nifty 50 futures.
With each futures contract at ₹5,00,000, the
investor shorts 10 Nifty 50 futures contracts at the
current index value of 14,800 points. This strategy
allows them to mitigate potential losses in half of
their portfolio's value during market downturns,
while still benefiting from market stability or
upturns in the remaining unhedged portion of the
portfolio.
7. Conclusion
Derivatives such as futures and forwards offer potent
hedging capabilities, ideal for mitigating financial
risk. However, a significant portion of market
participants primarily engage as speculators,
potentially hindering the broader understanding and
utilization of these tools for prudent risk
management. Increased education and awareness
are crucial to unlock the full potential of
derivatives for effective hedging in financial
markets.
