BETA AND OPTIMAL HEDGE RATIO Sample Clauses
The 'Beta and Optimal Hedge Ratio' clause defines how the relationship between the value of a portfolio and a hedging instrument is quantified and managed. In practice, this clause specifies the calculation of the beta coefficient, which measures the sensitivity of the portfolio to market movements, and the optimal hedge ratio, which determines the proportion of the hedging instrument needed to effectively offset risk. By establishing these parameters, the clause ensures that hedging strategies are appropriately tailored to minimize exposure to market fluctuations, thereby helping parties manage financial risk more effectively.
BETA AND OPTIMAL HEDGE RATIO. The beta hedge strategy is quite similar but it is used when the cash portfolio to be hedged does not exactly match the portfolio underlying the futures contract. For this reason the optimal hedge ratio is calculated this time as the negative of the beta of the cash portfolio. The optimal hedge ratio or minimum variance hedge ratio is a concept that defines the degree of correlation between an asset or liability and the financial product (normally a futures contract) purchased to hedge financial risks. Currency futures are a trading instrument in which the underlying asset is a currency exchange rate, such as the euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets (index and commodity futures markets) and are traded in the same manner. Currency futures are standardized contracts that trade on centralized exchanges. These futures are either cash settled or physically delivered. Cash-settled futures are settled daily on a ▇▇▇▇-to- market basis. As the daily price changes, the differences are settled in cash until the expiration date. For futures settled by physical delivery, at the expiration date, the currencies must be exchanged for the amount indicated by the size of the contract. Foreign exchange futures contracts have several components outlined below: Underlying Asset – This is the specified currency exchange rate Expiration Date – For cash-settled futures, this is the last time it is settled. For physically delivered futures this is the date the currencies are exchanged Size – Contracts sizes are standardized. For example, a euro currency contract is standardized to 125,000 euros Margin Requirement – To enter into a futures contract, an initial margin is required. A maintenance margin will also be established and if the initial margin falls below this point, a margin call will happen meaning the trader or investor must deposit money to bring it above the maintenance margin