Study On High Leverage And Hedging Strategy Finance Essay

Study On High Leverage And Hedging Strategy Finance Essay

Trading in Nifty hereafters is really risk as investor can confront heavy loss. Trading requires lot of experience in foretelling market. 75 % investors in India are little investors, which mean that they concentrate more on purchase. Traders must open an history with securities firm house and so they can get down trading on border ( purchase ) . Traders have to put 5 % to 10 % of the entire size of the contract as initial border to buy a contract and the remainder will be delivered by the securities firm house. When the market moves purchase can work against the investors and with the investors. If the market moves, so the border degrees are increased and the agent gives an indicant to the investors to add extra financess into the history in order to keep the future place. Bang-up future trading unmasking bargainers to high purchase which means that they have to put less and borrow big sum.

Leverage = Asset / Equity

If Nifty 50 hereafters trade at Rs 20,000

Then the value of one contract = Rs 20,000 x 25

= Rs 500,000

Initial border of Nifty hereafters = 10 % ten value of the contract

= Rs 50,000

Leverage = Rs 500,000 / Rs 50,000

= 10

If the bargainer has Rs 500,000 in the history can merchandise one Nifty hereafter contract. In this instance the purchase will be 1. This is the instance of high purchase trading. This means that there will be a 1 % opportunity consequence in a loss equal to the border. If the bargainer has Rs 100,000 in the history so the bargainer has the pick to merchandise the hereafter contract with Rs 100,000 from the history and borrowing the remainder of the sum from the agent. In this instance purchase will be 0.5 ( Ranganatham, 2004 )

High purchase is effectual in future contracts, because future contracts are fundamentally carried out in purchase. When purchase increases so the value of the contract besides increases as it is straight related to leverage. This point is proved from the equation of purchase. This shows that when there is high purchase so bargainers have to set less money in the history for buying the hereafters and if the market moves down in the hereafter so the bargainers has to confront less loss in the border ( less loss in the money they have put to buy the hereafter ) . ( Jay Seth, 2007 )

3 ) Minimizing Risk through Hedging Strategy

Index hereafters are the most of import and utile medium for fudging in the Indian market. In trade good and currency markets this is non utile, as the trade good and currency markets are non substitutable with each other. Hedging in Nifty hereafters is effectual merely when there is a correlativity between alterations in monetary values of the implicit in plus and the hereafter contract. Hedging does non ever better the fiscal result, but it reduces the uncertainness. Hedging may be affected by footing hazard, which arises because of the differences between the termination day of the month and the existent merchandising day of the month of the hereafter contracts. Basis hazard arises due to two grounds and they are, plus that is hedged might be different from the one underlying Nifty hereafter contract, and equivocator does non cognize the exact clip of the bringing of future contracts. In future contracts there are two types of hedge and they are:

1 ) Short Hedge

2 ) Long Hedge

Short Hedge

It is a procedure of adding short place to long place. It is a procedure that protects the bargainers against diminution of monetary value of Nifty hereafter contracts in the implicit in assets. The alterations in the value of long place in the implicit in plus are offset by equal and opposite alteration in the short place of the implicit in plus. This is explained good with the aid of an illustration. The undermentioned chart shows that an investor holds portfolio of different companies on December 12, 2003 ( Deepak Gupta, 2003, p.10 )

The investor predicts the market motion in the hereafter and when the investor feels that the market will travel down in the hereafter the investor will travel abruptly in order to protect against the monetary value hazard. “ Traveling short ” means that the investor will sell Nifty hereafters.

Figure 2.4 ( Rudhramurty, 2005 )

The above chart shows that Global Tele has the highest hazard ( as the beta is high 2.06 ) as the sum of keeping the stock of this company is Rs 200,000. It is of import for any investors to cipher the figure of future contracts for hedge intents. The figure of NIFTY hereafter contracts for fudging intent is calculated as follows:

Figure 2.5 ( Rudhramurty, 2005 )

Date

Open

High

Low

Near

Volume

Adjusted Near

9 Dec ‘ 03

1646.40

1677.90

1646.40

1675.85

345108500

1675.85

10 Dec’03

1675.75

1697.30

1672.65

1686.90

359809900

1686.90

11Dec ‘ 03

1,688.35

1,701.70

1,701.70

1,695.40

304,345,700

1,695.40

12Dec ‘ 03

1,695.80

1,705.95

1,686.45

1,698.90

299,741,400

1,698.90

The above chart shows the historical monetary values of Nifty hereafter contracts.

Portfolio beta of all the companies mentioned in figure 2.3 is = P1 r1 + P2 r2 + P3 r3 + P 4 r4

Portfolio beta = ( Rs 400,000 x 1.55 ) + ( Rs 200,000 x 2.06 ) + ( Rs 175,000 x 1.95 ) + ( Rs 125,000 x 1.9 )

= 1.61

Nifty hereafters on December 12, 2003 was 1698.90

Number of Nifty hereafters = ( Total value of portfolio x Beta / Value of Nifty hereafters on December 12, 2003 )

Number of Nifty hereafters = ( Rs 1,000,000 x 1.61 / 1698.90 )

= 947.67 = 948 contracts about

One Nifty hereafter contract is 200 units.

Number of Nifty future contracts required for fudging intent

=948 / 200

= 4.74 = 5 contracts ( about )

Long Hedge

Long hedge is a procedure of adding long future place to short place in the implicit in plus. Traders that use long hedge do non have the implicit in plus, but they plan to get it in the hereafter. It is good to those bargainers who plan to buy implicit in plus and lock in the purchase monetary value. Long hedge is used to fudge against a short place and this can be proved with the aid of an illustration ( Prasanna Chandra, 2004 )

Assume that in bull market, an investor expects to gain Rs 2,000,000 in 1 month clip. If the investor waits for two months to put so it means that the investor can lose the bull market wholly. The best option for the investor in this scenario is to utilize NIFTY future market. The investor could purchase NIFTY hereafters contract that has sum equal to Rs 2,000,000. This procedure is called long hedge ( Rudhramurty, 2005 )

The figure of future contracts that investor should purchase for long hedge is calculated as follows:

Assume that on December 12, 2003, the value of NIFTY hereafters was 1698.90. The investor expects to have Rs 2,000,000 by the terminal of January 2004. The investor has to purchase June Nifty hereafters in May and the figure of contracts he/she should purchase to cut down hazard is calculated as follows:

Number of contracts = Amount expected by the investor / ( 1698.90 x 200 )

= Rs 2,000,000 / ( 1698.90 x 200 ) = 5.88 contracts ( about 6 contracts ) .

Optimum hedge ratios are used to happen out the fudging effectivity of S & A ; P CNX Nifty hereafter contracts over a period of December 1, 2003 and January 1, 2004. In this survey, Error Correction Model ( ECM ) is used to gauge the optimum hedge ratios. This theoretical account is a additive arrested development alterations on topographic point monetary value and future monetary value. CRM can be expressed as:

I”St = a + I? . I”Ft + U ( T ) + N”

Where St = Spot monetary value of Nifty

Ft = Future monetary value of Nifty

ut = Error term

N” = Standard mistake

a= Constant ( For Nifty a =0.001388 )

Optimum hedge ratios are defined as the ratio of difference of discrepancy of unhedged place and the discrepancy of weasel-worded place to the discrepancy of unhedged place. The tabular array below shows the consequences of ECM.

Table: 2.6 ( Shivraj, 2004 )

Puting the above value in the undermentioned equation, we have

I”St = a + I? . I”Ft + U ( T ) + N”

0.40 = 0.001838 + I? x 0.492 + ( -0.000483 ) + 0.001

I? = Optimal hedge ratio = 0.8103

The incline coefficient I? is greater than 0.5 and closer to 1, which means that the hedge is extremely important. As the standard mistake increases the optimum ratio I? reduces and this shows that the fudging effectivity reduces as the standard mistake additions. This answers the research inquiry that hedge has a important consequence on Nifty future trading ( Shivraj, 2004 )

Effectss on Italian Stock Exchange

The consequence of presenting stock index hereafters on the volatility of Italian stock exchange was examined through GARCH theoretical account. Bologna and Cavallo ( 2002 ) used GARCH theoretical account to capture the fluctuation of volatility utilizing day-to-day shutting monetary value of Milano Italia Borsa stock index ( MIB ) between December 1, 2003 and January 1, 2004. GARCH theoretical account showed there was no destabilization of Italian topographic point market after the debut of hereafters contract in Italy. GARCH theoretical account concluded that the volatility of Italian stock market reduced after the debut of hereafters contract in Italy due to impact of increased new or recent intelligence ( Bologna and Cavallo, 2002 )