Derivatives & Hedging Strategies Flashcards
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Read the first 7 Derivatives & Hedging Strategies flashcards as text
A fund manager holds a long equity portfolio and buys put options to hedge downside risk. This strategy is best described as:
Answer: A protective put
Buying put options on an existing long position creates a protective put, limiting downside while preserving upside.
Which Greek measures the rate of change of an option's delta with respect to the underlying asset price?
Answer: Gamma
Gamma measures the convexity of the option's value, i.e., how fast delta changes as the underlying price moves.
A basis swap involves the exchange of:
Answer: Two different floating rate payments
A basis swap exchanges two floating-rate cash flows tied to different reference rates, such as SOFR vs. T-bill rate.
When a futures contract is in backwardation, the futures price is:
Answer: Lower than the current spot price
Backwardation occurs when futures prices are below the current spot price, often due to high convenience yields or supply shortages.
A fund uses a cross-hedge to manage currency exposure on a position in Danish Krone (DKK) using Euro (EUR) futures. The main risk of this approach is:
Answer: Basis risk between DKK and EUR
Cross-hedging introduces basis risk because DKK and EUR, while correlated, do not move in perfect lockstep.
An interest rate cap is equivalent to a portfolio of:
Answer: Interest rate call options (caplets)
An interest rate cap is composed of a series of individual caplets, each being a call option on a future interest rate fixing.
The minimum variance hedge ratio is calculated as the ratio of:
Answer: The covariance of spot and futures changes to the variance of futures changes
The optimal hedge ratio equals Cov(ΔS, ΔF) / Var(ΔF), minimizing the variance of the hedged position.