Derivatives and Hedging
This article discusses the use of derivatives to hedge risk. Derivatives are financial instruments that derive their value from an underlying asset, such as a commodity, currency, or interest rate. Hedging is the process of reducing risk by taking a position in a derivative that offsets the risk of another position.
Here are some of the key points from the article:
- Derivatives are financial instruments that derive their value from an underlying asset.
- Hedging is the process of reducing risk by taking a position in a derivative that offsets the risk of another position.
- Futures contracts have several advantages over forward contracts, including liquidity, standardized terms, and the mark-to-the-market convention.
- The two types of hedges are short hedges and long hedges. A short hedge involves selling a futures contract, while a long hedge involves buying a futures contract.
- Interest-rate futures contracts are priced using the same type of net present value (NPV) analysis that is used to price Treasury bonds themselves.
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