Hedges, it is "counter transactions", has more than a century of existence, it may seem strange - in fact the bulk of publications and scientific studies on the subject falls on the 80th and 90th years of the twentieth century. However, doubts that even in 1848, are traded on the Chicago Board of Trade futures contracts on grains could be used to offset market risks, it is not necessary. You can also say with certainty that the entire structure of the broadest in the market for financial derivatives owes its existence to the need for insurance of risks due to the presence of general market uncertainty. Of course, speculation, which has a number of features in common with the hedging which is not less than the objective nature, but still can not match the latest on the gross volume of deals. Modern derivatives market developed countries - a market hedgers rather than speculators. However, hedging remains to some extent, "the lot of the elect", and not only in Kazakhstan. This activity allowed only professionals of the highest caliber, and for good reason: the careless use of financial instruments can apply to "play with fire", and achieved effect will be opposite the expected. In fact, the decision to hedge in large corporate level can only take the risk manager or the CFO, who is directly subordinate to the Managing Director. That, however, is not a corporation insures against loss.
After all, the supreme director of Procter & Gamble, due to the complicated interest rate swap with the additional borrowing (levered swap), prisoner of Bankers Trust from November 2, 1993, led the company to more than two hundred millionth loss in 1994 and lost their seats. Although probably fair to write off the losses on account of the unprecedented increase in interest rates on five-year Treasury notes. Of course, the known and much more successful examples.
So, after a drop in oil prices in 1986 from 35 to 11 dollars per barrel, there is a situation in which the treasury of Texas, a quarter of which depends on oil duties, practically devastated. Size uncollected duties amounted to $ 3.5 billion. To this situation is not repeated in the future, tax revenue hedging program was developed with the help of options. All transactions were concluded on NYMEX (New York Mercantile Exchange). The operation started in September 1991, to hedge price was chosen at $ 21.5 per barrel (for the duration of the hedge - 2 years - the level of prices varied from $ 22.6 to $ 13.91 per barrel). hedging program was drawn up in such a way that a fixed minimum price of oil ($ 21.5 per barrel), and the state gets an additional profit when oil prices rise. This technique allowed the state government to receive a steady income for two years with significant fluctuations in oil prices.
There are many definitions of hedging. Although they are similar, it is reasonable to give some of them for more in-depth analysis of the nature of this process.
1) Hedging - is to use a single tool to reduce the risk associated with the adverse impact of market factors on the price of the other associated with the tool it, or to cash flows generated by them;
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2) Hedging - a change in insurance risk asset prices, interest rates or the exchange rate with the help of derivative instruments;
3) Hedging - is the use of derivative and non-derivative financial instruments (the latter only in limited cases) for partial or full compensation for the change in fair value of hedged items, ie the protected financial instruments;
4) Single position on a financial instrument, which reduces the exposure to the total cash position of any of the risk factors is called hedging;
5) Hedging - the elimination of the uncertainty of future cash flows, which allows you to have a solid knowledge of the value of future earnings as a result of commercial activity
In official documents Futures US Trading Commission (CFTC - Commodity Futures Trading Commission) emphasized that this hedge must include positions in derivative contracts that are economically related to the cash (hedged) position and are intended to reduce the risks arising in the ordinary course of business of the company. Summarizing these definitions, it is possible to do 3 main conclusions:
A. Any asset, cash flow or financial instrument is exposed to the risk of impairment. These risks, according to the general classification, are divided mainly on price and interest. Separately, you can highlight the risk of non-contractual obligations (since the financial instruments are essentially contracts), called credit.
B. In order to protect against loss of money for a particular asset (instrument) to another position on the asset can be opened (instrument), which, according to the hedger is able to compensate for this type of loss.
C. This operation is called hedging.
However, it should be noted that in the modern interpretation of the concept of financial management of the hedge has a few more extensive and covers the entire set of actions aimed at eliminating or reducing risks with the nature of occurrence of the external sources. The same concept asserts that the use of financial derivatives for the purpose of risk management is convenient, but not necessary. Strive to use derivative contracts only because they are available - a rash decision; perhaps there is even more simple (and cheap) way. A lack of access to liquid derivatives (for example, on undeveloped markets), in turn, does not mean the collapse of the system of risk management.
Types of hedging
Hedging sale. Hedging sales - is the use of a short position in the futures market for those who have a long position in the cash market. This type of hedging is undertaken for the protection of the selling price of the goods. It is used sellers of real goods for insurance against falling prices of this commodity. This method can also be used to protect the stock of goods or financial instruments not covered by forward contracts. Finally, a short hedge is used to protect future products or prices on the forward purchase agreements.
Short hedge begins selling a futures contract and terminated its purchase.
Here are a few situations that require the use of a short hedge. The trader bought a corn farmer in October, at a certain price. Grain placed in the warehouse and at risk of falling prices. Merchants can sell futures contracts, for example, in December, and to keep his position until it finds a buyer for the grain, after which he will eliminate his position. Alternatively, the dealer may have a supply of bonds, half of which was sold at a favorable price, and the other - is not yet sold. In order not to risk a fall in prices in relation to the other half, he can sell the corresponding number of futures contracts. If prices fall, a short position in the futures market will become a refuge for the remaining bonds. When a dealer sells more any portion of this reserve, it will reduce its futures position.
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Consider the situation shown in which the locking mechanism via price hedging.
Hedger wants to hedge against a possible fall of stock prices (usually by means of futures contracts on the index shares, rather than shares themselves). He has the action, which now costs 100 tenge, and a month later it will need money for the purchase of real estate. However, the expectation that the price per share at the time of purchase will fall and it will not be able to pay for your purchase, it is pre-hedge:
a) it is, say, in January sells futures contract with delivery through three months at a price of 110 tenge per share and thus advance fixes his price. On the stock exchange jargon, this is called "to lock the price";
b) the sale of shares in the real market in February, it really sells it at a price lower than the desired - 90 tenge;
c) simultaneously eliminated (redeemed) futures contracts at the current price of the futures market - 100 tenge. The result is as follows (Table 1):
Table 1
Redemption of futures contracts
| Months | Cash market | Futures market |
| January | Target price 100 tenge | Sale of a futures contract for 110 tenge |
| February | The sale of shares by 90 tenge | Buying a futures contract 100 tenge Profit 10 tenge |
The final price: 90 + 10 = 100 tenge.
As a result of this loss of operations in the cash market were offset by gains from hedging, which made it possible to get the intended hedger prices.
Knowing the approximate amount of their shares, the hedger can insure all the sold quantity. So, if he knows that the number of its shares is 20 thousand. Pieces, it will acquire four futures contracts for 5 thousand. Pieces each. At the same time, if in the above example, in the cash market prices have risen, contrary to expectations, the additional profits obtained here would go to compensate for losses on futures transactions (Table 2).
Table 2
Futures transactions
| Months | Cash market | Futures market |
| January | Target price 100 tenge | Sale of a futures contract for 110 tenge |
| February | The sale of shares by 105 tenge | Buying a futures contract 120 tenge Loss 5 tenge |
The final price is: 105 - 5 = 100 tenge.
This example clearly shows that hedge not only reduces potential losses, but also deprives the additional profit. So, in the second case the shareholder may receive additional profit by selling shares at 105 tenge, if it does not hedge. Therefore, hedgers typically not insure the entire volume of production, and some part of it.
Hedging purchase. This operation is the purchase of a futures contract by anyone having a short position in the cash market. The result of a long hedge is to fix the price of the product purchase. It is used to protect and risks arising from the forward sales at fixed prices, and a rise in prices for raw materials used in the manufacture of a product with a stable price.
This type of hedging is often used brokerage firms have orders for the purchase of goods in the future, as well as companies - processors. In this case purchases are made on the futures market as a temporary replacement of the purchase of real goods. As a result, a long hedge protects against rising prices.
For example, the consumer knows that he needs to purchase 10 thousand. Barrels of oil in two months, but fears of price increases compared with the current level of $ 55 per barrel. Immediate purchase is impossible for him, since he has no storage. In this case, he buys 100 futures oil contracts on the stock exchange and sell them when the will to enter into a contract for the supply of the real. The overall result of the operation (Table 3):
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Table 3
The contract for the supply of real
| Months | Cash market | Futures market |
| January | No deals The target price is $ 55 per bbl | 100 purchase of March contracts for $ 53 per bbl |
| March | Buys 10 thousand. for $ 83 per bbl | Sale 100 March contracts for $ 81 per bbl Profit of $ 28 per bbl |
The final price of purchase: 83 - 28 = $ 55.
The costs of a futures contract itself will be insignificant, although the margin payments and loan will be higher than in the rapid elimination of the transaction, since the futures contracts held for two months.
Hedging with futures contracts has several important advantages.
1. There is a significant reduction in price risk of trade in goods or financial instruments. Although it is impossible to completely eliminate the risk, however well-executed hedge on the market with a relatively stable basis eliminates a large share of danger. It increases the stability of the financial side of the business, minimizes fluctuations in earnings caused by changes in commodity prices, interest rates or currency exchange rates.
2. Hedge does not interfere with normal operations and allows real-time protection without the need to change the price policies of stocks or engage in forward agreements inflexible system.
3. Hedging provides greater flexibility in scheduling. Since futures contracts are for the delivery of many months in the future, the company can plan ahead. Thus, the processor can buy soy beans only, if someone is willing and able to sell them to him. He must keep the beans and the finished product until someone does not buy it. With the futures contracts, it can control financial risk by replacing transactions with beans and their products on the transaction in the futures market. This makes more efficient management of excess inventory or shortages.
4. Hedge facilitates the financing of operations. In business, it decided to provide loans to secure supplies of commodities, and hedge plays an important role in determining the volume of the loan. For a non-hedging stock of goods bank provides credit, roughly equal to the company's own funds, which it can allocate for this purchase (i.e. the ratio of debt to equity will be 50/50 for the purchase of stocks). If these reserves are hedged, the share of bank credit can be up to 90%, and the rest is financed by the company itself (i.e. the ratio becomes 10:90). Suppose the company has 1 million USD. For the purchase of stocks of raw materials. It could be purchased at $ 2 million without hedging their reserves. ($ 1 million - a bank loan, and the rest - from the assets of the company). If the company has used futures contracts, it would buy $ 10 million of these reserves ($ 1 million - means the company, the rest - the bank credit). This gives obvious benefit companies, especially in a situation of business expansion. The good news is that the bank itself has more confidence in the credits that are issued against the liabilities covered by futures contracts.
5. If the hedge is started, it is not necessary to eliminate it only when the implementation of the real deal. It is possible to conduct operations "inside" of the hedge, the mercy of the contracts ahead of time and then again their selling if prices have gone up. In this case, the extra profits. However, these operations become speculative in nature, as futures position becomes equal in quantity and not on the opposite direction of the real market.
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Analyzing the listed hedge examples, we can see that this operation is used as a temporary replacement surgery in the real market, which will be implemented in the form of transaction for immediate delivery. Consider other examples in which are alternative ways of behavior of the seller and the buyer to protect against price risk.
Suppose the farmer grown wheat, but he does not have the appropriate repository. This means that during harvest it should be sold whole wheat or resort to commercial storage.
December 1 of the Chicago Stock Exchange July wheat futures contracts available for $ 3. / bu. and forward the bid price for wheat for delivery in harvest time is 2.65 USD. / bu. These terms and conditions on the market meet the seller in relation to the price target and decides to hedge part of the expected yield by selling the July contract for three 5th. Bushels and fixing the futures price at $ 3 / bu. Seller believes that basis will increase compared to its current level of -35 cents, which is based on the bid price cash forward contract.
Suppose that the spot price has fallen to $ 2.3 / bu. at the time of harvest, and the July wheat futures were offered at $ 2.55 / bu. Because the seller took the hedge, he was protected from the reduction in the cash market. His initial futures position - sale of three of July futures for wheat at $ 3 / bu. and the reverse position - buy three contracts at $ 2.55 / bu. They allowed him to win in the futures market of 45 cents per bushel. This profit offsets the seller lower the yen in the cash market - $ 2.3 / bu. and thus, its selling price is $ 2.75 / bu. (2.3 + 0.45). The overall result is as follows (Table 4):
Table 4
Ways to conduct the seller and buyer to protect against price risk
| Date | Cash market | Futures market | Basis |
| December 1st Harvesting | Buyers price $ 2.65 The selling price of $ 2.3. | For sale of futures at 3.0 USD Buying futures for $ 2.55 Profit $ 0.45 | -35 cents -25 cents |
Each of the possible operations worked as follows:
1) If the seller did not use any of the pre-operations and would simply sell their goods during the harvest season, its selling price would be $ 2.3 / bu.;
2) if it is 1 December concluded a forward contract on the spot market, its selling price amounted to US $ 2.65 / bu.;
3) by resorting to hedging the sale, he got $ 2.75 / bu. (10 cents more than the bid price in cash forward contract), as a basis increased from -35 to -25 cents for the July quotation.
Now suppose that the period of harvest rates in the cash market rose to $ 3.4. /bu., and July futures were offered at 3.65 USD / bu. In this case, the seller would sell the crop at a higher price - $ 3.4 / bu. but also in the futures market would have suffered losses (65 cents per bushel), the mercy of futures contracts (Table 5).
Table 5
Ways to conduct the seller and buyer to protect against price risk
| Date | Cash market | Futures market | Basis |
| December 1st Harvesting | Buyers price at 2,65 USD The selling price of $3,4 | For sale of futures at $ 3.0 Buying futures for $ 3.65. The loss of $ 0.65. | - 35 cents - 25 cents |
In this situation, each of the possible operations would work as follows:
1) if the dealer waited until the harvest, and then sold the wheat, its price would be $ 3.4. / bu. (This operation is very risky);
2) if he has chosen a forward contract the cash market, the price of his wheat would be $ 2.65 / bu.;
3) due to hedge the sale price would be equal to $ 2.75. / bu., as a basis increased to the expected level of -25 cents.
This example shows that a short hedge made if not the best possible results, and not the worst.
Similarly, there is a situation for a long hedge.
Suppose a farmer calculated that in mid-November he will need as livestock feed 20 thousand. Bushels of corn. He expects that by the time prices will rise from the current level.
At the moment, the price of the December futures contract for corn is $ 2.2. / bu., His usual supplier of corn wants to sign a contract for the supply during the harvest at a price of $ 2.0. / bu. Since the buyer expects that the basis will be weaker and will be equal to approximately -30 cents, i.e. A. the purchase price will be $ 1.9 for it (2.2 - 0.3). He refuses to sign a forward contract and decides to hedge their spending on food, using the December futures contract. To insure the purchase price, he buys 4 December futures contract on the Chicago Mercantile Exchange corn 5 thousand. Bushels each priced at $ 2.2. / bu. In November, as expected, prices have increased, and December futures are offered at $ 2.6. / bu., and the price of corn in the cash market is $ 2.3. / bu. As a basis reached the expected level - 30 cents (2.3 - 2.6), the farmer decided to liquidate the hedge.
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He buys corn in the cash market at $ 2.3. / bu. and eliminate their futures position by selling 4 December futures contract at $ 2.6. / bu. As you can see, a profit of 40 cents per bushel on the futures market is balanced by the higher purchase price in the cash market (Table 6).
Table 6
Ways to conduct the seller and buyer to protect against price risk
| Date | Cash market | Futures market | Basis |
| July November | Seller price 2.0 USD The purchase price of $ 2.3 | Buying futures at $ 2.2. Selling futures at $ 2.6. Earnings of $ 0.40. | - 20 cents - 30 cents |
The final purchase price is 2.3 - 0.4 = $ 1.9.
If a farmer did nothing and waited for needed food, the purchase price would be equal to $ 2.3. / bu. If he took the cash forward contract market, the purchase price would be $ 2.0. / bu. And resorting to hedging to lock the feed costs, he made the purchase at the price of $ 1.9. / bu.
This hedge was more effective than the forward contract, as the basis has become weaker and reached the expected level. As with the previously discussed hedge examples, the risk is limited to changes in the base level.
Another benefit of the hedge (short) arises from the producers of seasonal products. For them, the futures market allows to insure the costs of storage and more accurately determine the time of sale spot.
Hedging techniques
By hedging techniques include: structural balancing; gap control between sensitive assets and liabilities (GEO-management); management weighted average maturity (duration); entering into forward and futures contracts with the aim of creating offsetting positions; conducting security operations through the options; exchange of payments in accordance with the balance characteristics of participants of the transaction (swap contracts).
If the selection of assets and liabilities at amounts and terms is carried out in the framework of balance sheet positions, such an approach to managing price risk is called natural (or natural) hedging. To this type belong the first three methods of the just mentioned. The use of off-balance sheet activities is viewed as artificial or synthetic hedge. The content of this reception is to create off-balance sheet (artificial) position, which allows to obtain compensation for the financial losses the balance sheet position in the case of the price risk.
Off-balance sheet position is formed as a result of the conclusion of financial transactions, which the mechanism of action helps to minimize price risks. These contracts are derivatives, or derivatives (from the English Derivative -. A derivative), the value of which is derived from the value of the underlying asset (money, currency, securities).
derivatives transactions carried out on the futures market. The vertical cut financial market represented by two segments: spot and forward. On the spot market transactions are concluded, the terms of which provides for the real deal (purchase, sale, lending, etc.) for a maximum of two working days from the date of the contract. Another name for this market - cash (cash). On the spot market transactions are concluded at the current market price.
If the period from the date of conclusion of the transaction to the date of execution of two working days, the agreement called urgent, and the market - urgent or forward. In practice, the indicated period may be several years, although usually it is 1 - 3 months. On the futures market transactions are concluded at the forward price, which reflects expectations about future changes in the price of the underlying asset. Futures contracts provide a preliminary definition of all terms of the agreement, including the contract price, which will happen on the real deal in the future. This allows both parties to become independent from the volatility of market prices during the period from the trade date until the date of its implementation.
Futures and Options Market is a complex and development of organisms. market infrastructure includes the leading exchanges of the world, the international OTC trading system based on electronic means of communication and a wide range of organizations engaged in brokerage and dealer functions. The most active and directly involved in the urgent financial market are commercial banks that conduct transactions with both own resources and from clients' funds on their behalf. Derivative financial instruments are forward contracts, financial futures, options and swap contracts, as well as hybrid instruments - swaptions, options forward transactions, options to buy (sell) futures, etc.
Transactions in derivatives are held to a hedging price risks, and obtain speculative profits (due to the favorable price changes). The operation of forward transactions classified as hedging in the case where the bank has a balance sheet position that there is a risk of financial loss due to changes in market prices, and is accounted for under this balance sheet position between the price of the underlying asset and the price of derivatives there is a relationship which gives the ability to significantly reduce the overall price risk. If the amount and timing of off-balance sheet positions coincide with the corresponding parameters of the balance sheet position, it allows you to compensate for the loss of one of these positions, the profit for the other. Sometimes the hedging operations only understand derivatives, which provide protection against price risks.
Depending on the purpose for which the operation of the futures market, all the participants can be divided into two groups, hedgers and traders (speculators). Hedger - a natural or legal person having a carrying position and carries out operations with derivatives to hedge the risk of this position. The essence of hedging transactions is to transfer price risk to the hedger to another market participant. The hedgers are interested in the final result as the sum of income and losses on balance sheet and off positions. Sellers, on the contrary, is calculated only on making a profit from the difference between the purchase and sale of derivatives. Hoping to get speculative profit, traders take the risk hedgers. For efficient operation of the market need and hedgers and traders, which provide him with high liquidity.
To protect against possible losses in the future held insurance operations along with hedging transactions in the urgent financial markets. security operation is to conclude an agreement with the player in the market, which for a fee agrees to compensate losses related to changes in asset prices. Consequently, the risk of changes in asset prices is transferred to the participant, who received an award - the insurance premium. insurance operation based on pre-payment of premiums for the possible compensation of future losses, regardless of whether the losses will occur or not. This does not exclude the possibility of taking advantage of the favorable changes in asset prices. There is a significant difference between hedging and insurance operations.
Effects of hedging are symmetrical. If one of the items a profit, then for the other place will have a loss. And the consequences of asymmetric security. This means that the insurance compensates for the negative consequences, allowing to benefit from favorable market conditions. The price for the opportunity to earn extra income is a premium. The cost of insurance operations far exceeds the value of the hedging operations, the costs of which are very small and, in comparison with the amount of operation, can not be taken into account. hedging transactions are carried out with the help of tools such as forward and futures contracts, swap transactions and financial risks of insurance operations are carried out with the help of options.
And hedging and insurance are intended to protect against risks, and so it is legitimate to consider these operations as a whole, make up the hedge process. That is why the options, which the mechanism of action reflects the essence of insurance, referred to as hedging instruments, along with forwards, futures and swaps. Choosing balance position on the timing and amount (i.e. exercising a natural hedge), the Bank does not require the participation of other market participants, who would take the risk.
In general, hedging process allows significantly reduce or completely eliminate the risk. hedging theory is immune to bank balance, protecting against unforeseen price changes in the market. Hedging is a way to stabilize the market value of the banking institution. But as between risk and return, there is a direct correlation, the low level of risk means limitation of opportunities to make a profit. Consequently, hedge drawback is that it does not allow hedger use the favorable development of the market situation.
Therefore, managers can not all hedge balance sheet positions, but only some of them. Creating a protection against price risks for the entire balance is called complete or makro hedging and transactions that hedge the individual active, passive or position - partial or mikro hedging.
Risks arising from changes in future prices of financial instruments, hedging is not required. Banks can take risks in the hope of favorable changes in prices, which would give an opportunity to get speculative profit. This approach to management strategy called non-hedging.
Given the inability to take advantage of favorable circumstances in risk hedging transactions, banks and their customers can use the strategy consciously does not hedge when some of the assets or liabilities is sensitive to changes in market parameters (interest rates, exchange rates). The strategy does not hedge aims at maximizing profits, and is accompanied by an increased level of risk. With this approach, the bank is not protected against adverse changes in the market and can incur large financial losses. hedging strategy to stabilize the profit for the minimum level of risk, and provides an opportunity to get the same results regardless of the volatility of financial markets. Choice of strategy depends on many factors, first and foremost - from the tendency of the bank to risk.
However, not always the choice of risk management strategy is an internal matter. Some banks may not allow their clients to speculate. In providing services to the client the bank has the right to insist on hedging, because the risks faced by the client, may result in losses of the bank. In some countries, supervisors forbid commercial banks to conduct speculative operations. And sometimes your own bank's management restricts the level of acceptable risk limits. Hence, the need of hedging confronts many market participants.
On international financial markets, there are many potential hedgers: Trade dealers of government securities and foreign currencies, which are protected by lower yields and exchange rates; investment banks, who use futures market for the sale of more current assets than it can be done on the spot market; exporters and importers to protect the future payments from changes in exchange rates; Corporation to fix the interest rate on attracted and placed funds; companies engaged in transactions with the property, the issuance of convertible shares are protected from possible interest rate increase until the completion of the issuance and placement; pension funds protect the income from investments in gilts and Treasury bills; banks that are protected from the reduction of credit interest rates and the increase in deposit rates in the future; mutual funds to protect the nominal value of financial assets, which they have, or fix prices for the financial instruments that will be purchased in the future.
This list of hedgers is far from complete, but it gives an idea of the diversity of the types of organizations that may use the term market transactions to reduce exchange-rate risk, interest rate risk, or in the stock market.
