Question

1. If you must buy some asset in future and you just want to hedge the risk what sort of derivative trading will you do? Explain in brief with payoff diagram.

2. If you have long position in one asset and you want to hedge the risk of price drop in that asset while still having the upside in case the asset price goes up, what sort of derivative trading will you do? Explain in brief with payoff diagram.

3. Briefly explain the benefits of having a thriving capital markets even in an economy like India where banking system provides most of the funding to firms.

4. What are the four types of traders? Name two types who facilitate the price discovery process and briefly state how do they facilitate?

Answer 1

Who wants to hedge future production to overcome risk of losses will have a fear of price going down than the current price and he may suffer loss. To over come this risk he should short (sell) the future contract today and lock the sale price now irrespective of whatever the price be his price for sale will be locked at which hedges the risk of price going down or any losses.

Reason - as the producer hedged the future value of gas by short selling future contract he will have to Buy the futures to close the contract, which will cause him a loss