Question

Suppose that spot and futures prices of the underlying asset when hedge is initiated are $26.50 and $24.20 respectively, and when hedge is closed out are $25.00 and $24.99 respectively.which one is true from the followings?

1.effective price paid = $24.21

2.Basis risk when hedge is closed out = $2.3

3.both 1 & 2

4.none of the above

Answer 1

Sol :

When spot and futures prices of the underlying asset hedge is initiated at $26.50 and $24.20 respectively, the basic risk when hedge is closed out is = $2.3. When hedge was initiated difference between spot and future price is the risk you carry, as on expiry the spot and future price will be the same.

Spot price of underlying asset = $26.50

Future price of underlying asset = $24.20

Basic risk when hedge is close out will be $26.50 - $24.20 = $2.30

Therefore option 2.Basis risk when hedge is closed out = $2.3 stands out to be true.