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(An Exchange Risk Off-Setting Tool)

A Hedge is an investment to reduce the risk of adverse price
movements in an asset.
a) Risk offsetting tool
b) Similar to insurance.
c) Not to make money but to reduce losses.
History of Hedging
 Alfred Jones is called the Father of Hedge Fund. He was the First
Money Manager.
 In the year 1968, 140 Hedge funds were available.
 During 1969-70, heavy looses occurred and it was unsuccessful
 In the year 1999-2000, Hedge fund rejuvenated and till now it exist
successful to reduce the loss to certain limit.
Hedging Instruments
Forward Contracts
Future Contracts
Call option
Put Option
Forward Contract
• It is an agreement to buy or sell an asset at a certain future time for
certain price.
• Mr.X –Importer has to make a payment in $ for consignment in 6
month time- not sure what the Rs./$ then – contract with a bank to
buy $ in 6 months from now at a decided rate.
Future Contract
• A Future contract is an agreement between two parties to buy or sell
an asset at a certain time in the future at a certain price.

• Example: An Automobile manufacture – huge quantities of steel as

raw material – export contract – risk of increasing steel prices – buy
steel future contracts, the automobile manufacturer is protected.
Futures & Forwards

Future Contract Forward Contract

• They trade on exchange. • Trade in OTC Markets.
• Are Standardised. • Are Customised.
• Regulated. • Not regulated.
• Easy to terminate. • Difficult to terminate.
• Less costly • More Costly
Call Option
• An option is a contract between two parties giving the taker (buyer)
the right, but not the obligation, to buy or sell a parcel of shares at a
predetermined price. To acquire this the buyer pays a premium to the
writer (seller) of the contract.
• Example: Mr.X purchases a August Call option at Rs.40 for a premium
of Rs.15. That is he has purchased the right to buy the share at Rs.40
in August. If the stock rises above Rs.55(40+15) he will break even
and he will start making profit.
Put Option
• A Put Option gives the holder of the right to sell a specific number of
shares of an agreed security at a fixed price for a period of time.
• Mr.X purchases Y Ltd. AUG 3500 put premium 200. This contract
allows Mr.X to sell 100 shares of Y Ltd at Rs.3500/share at any time
between the current date and the end of August. To have the
privilege, X pays a premium of Rs.20000 (Rs.200/share for 100