Question

1. What is an example of using derivatives for "Risk Management"?

2. LUV stock is trading 500 dollars per share. Match 3 of these possible execution prices to the written order: 1)499, 2)500, 3)501. More than one price may apply to each order.

Sell 100 shares of LUV at the limit price of $500 ________ Buy 100 shares at the market price _________ Buy 100 shares of LUV at the limit price of $500 ________

Answer 1

1. Hedging is a good example of using derivatives for risk management. We take an offsetting position in the derivatives in order to protect from the downside. For example, if we have bought 100 shares, we can short futures in order to protect ourselves from the downward movement in prices.

2. Since we are selling at limit price, the execution price will be equal to 500.

Since we are buying at market price, the execution price might be equal to or more than 500. Hence, 500 and 501 are possible.

This is again a limit order, hence the execution price will be 500.