Trading Futures for Dummies by Joe Duarte

Author:Joe Duarte [Duarte, Joe]
Language: eng
Format: epub
Tags: Business & Economics, Insurance, Risk Assessment & Management, political science, Public Affairs & Administration
ISBN: 9780470287224
Google: BCDKsgEACAAJ
Publisher: Wiley
Published: 2008-07-08T00:20:19.826523+00:00

Hedging in general terms

In general, hedging is taking a position in the market that’s in the opposite direction of a trading position you’ve already established; it’s a form of insurance against a reversal of trends. You need to know what the opposition is doing anyway so that you’re better able to make your market move. In the world of short-term interest rates, aside from speculators, the big money comes from money-market funds and corporations.

Generally, money-market fund managers and corporate traders go long or short in the direction that’s opposite their borrowing or lending. Borrowers generally want to hedge against rising interest rates, so they tend to short the market. That way, if interest rates rise, they either reduce their future interest-rate costs or actually profit from the situation.

Money-market funds and corporations borrow and lend millions of dollars on a daily basis, so the short-term interest-rate market, especially in Eurodollars and related contracts, is the way they hedge their exposure. Here’s how hedging works for the various participants:

Lenders: Banks and other lending institutions want to hedge against falling interest rates, so they tend to be long on the market. They know that they’ll be lending money to someone in the future, and if interest rates continue to fall, their profits will be reduced accordingly. By using futures strategies, they lessen the impact of having to charge less interest and thus help curtail potential future losses.

Institutions decrease their risk when they sense that rates are going to fall by establishing long positions in bonds, T-bills, or Eurodollar futures contracts in order to protect their future earnings. The money that they make when they sell their contracts goes to the bank’s bottom line, balancing revenue lost from lending to customers at lower interest rates. This strategy is by no means perfect, but if the institution does it correctly, it at least cushions the blow.

Corporate treasurers: These big-money institutions use sophisticated formulas based on the need to protect their cash flow and future expenses. They also hedge against the risk of adverse international and geopolitical events and against nonpayment by high-risk customers by using the short- and long-term interest-rate futures markets.

For example, say you’re the chief financial officer at an international paper products company that has multiple risks, such as the price of lumber and pulp to make paper and related products and a large customer base in Latin America, meaning that political instability is a major factor you must consider when running your business. By using lumber futures and currency hedges and by varying your strategies based on market conditions and analysis, you can decrease the risk of material shortages and political instability to your company’s earnings.

Speculators: Traders just like you and me always want to trade with the trend, which is why technical analysis (see Chapter 7) is so helpful in futures trading. By the time a tick is printed on a chart, it’s as good of a snapshot as there is for all hedging and speculating that has taken place up to that instant in time.

Download

Copyright Disclaimer:
This site does not store any files on its server. We only index and link to content provided by other sites. Please contact the content providers to delete copyright contents if any and email us, we'll remove relevant links or contents immediately.