INTRODUCTION
1.1 INTRODUCTION OF THE STUDY
1
This study titled “a study on effectiveness of hedging in the MCX
futures” is being undertaken to analyze the effectiveness of hedging using
futures, which is a type of derivative, focusing on index futures, which is a
type of derivative, focusing on index futures. The study aims to identify the
hedging strategies in futures and assess the losses made by an investor in the
stock market. As such, the present study aims to identify the hedging strategies
in the real market condition. Derivatives being a new area sufficient care has
been taken to the subject and related topics in detail.
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CHART NO: 1
INVESTMENT AVENUES
INVESTMENT
AVENUES
National
Mutual funds Bonds and Bank fixed
Shares Life insurance savings
debentures deposits
certificates
3
MEANING OF STOCK EXCHANGE
Financial assets are claim of holders over issuer (business firms and
governments). They enter low different segment of financial market.
Both money market and capital market constitute the financial market.
Capital market generally known as stock exchange. This is an institution
around which every activity of national capital market revolves. Through the
medium stock exchange the investor gets on impetus and motivation to invest
in securities without which they would not be able to liquidate the securities. If
there would have been no stock exchange many of the savers would have hold
their saving either in cash i.e. idle or in bank with low interest rate or low
returns. The stock exchange provides the opportunity to investors for the
continuous trading in securities. It is continuously engaged in the capital
mobilization process.
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Another consequence of non-existence of stock exchange would have
been low saving of the community, which means low investment and lower
development of the country.
C - Cautious Approach.
K - Knowledge of Market.
H - High Yield.
A - Authentic Information
E - Equity
The first stock exchange was established in London in the year 1773.
Just after establishment of London stock exchange various countries like
France, Germany and USA also established their own stock exchange markets.
In India, the first exchange established in Bombay in the year 1875. Later, in
year 1908, Calcutta stock exchange was established which was recognized in
1923 and the madras stock exchange limited was established in 1973. So far
the government of India has recognized 22 stock exchanges, which was
located at major business centers in different parts of country.
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Till the mid fifties the stock exchange was governed by their own bye
laws and regulations with very little interface by the government. In the year
1925, the government of Bombay promulgated an act “securities contracts and
control act, 1625 for regulation and the stock exchange. During the Second
World War, trading outside the stock exchange flourished with adverse effect
on investor’s confidence due to base – less issues and higher rate of
liquidation of companies. In 1956, the Central Government passed contracts
(regulation) act 1956, which came into force through out the country on 20th
Feb. 1957.
Recently the government of India has enacted an act (SEBI Act 1952),
which provides for the establishment of a board to protect the interest of
investor in securities, the SEBI has emerged as a monitoring institution of the
country fir the development and regulation of stock market, SEBI has issued
from time to time guideline to insider trading listing of securities, registration
of intermediaries mutual funds etc.
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STOCK BROKERS
7
BASIC REQUIREMENTS FOR STOCK BROKERS
1. The broker must have a net worth of Rs. 50 lakh if he wants to avail
the facility of Internet for his own.
The above are some of the important pre-requisites for the stockbroker
should intend to take benefits of trading on Internet. However, detailed
guidelines issued by the SEBI for the stock exchange
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KIND OF STOCK BROKERS
1. Commission Broker
Near about all the brokers buy and sell securities for earning a
commission for investor point of view he is the most important person and
responsibility is to buy and sell stoke for his customer. It means that he acts as
an agent of investor and earns commission for his services rendered. The
broker is also an independent dealer in securities. He purchases and sells
securities in his own name but he is not allowed to deal with non-member.
2. Jobber
3. Floor Broker
The floor broker buys and sells shares for the other broker on the floor
of the exchange. He is an individual member owns his seat and receives his
own commission on the orders he execute. He helps other brokers when they
are buy and as compensation receives a portion the broker.
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5. Budliwala
6. Arbitrageur
For the process of trading in stock exchange there is the basic need for
a transaction between an individual and the broker execute customer’s order to
buy or sell on the stock exchange trading ring. The exchange of scrip between
the member of the exchange in from of buying or selling is called trading
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TRADING METHOD
* Settle the account, i.e. payment for securities sold on due date.
TYPES OF TRADING
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To participate in this system, the member-brokers need to indicate
number of MCX basket(s) to be bought or sold, where the value of one MCX
basket is arrived at by the system by multiplying Rs.50 to prevailing MCX.
For e.g., if the MCX is 4000, then value of one basket of MCX would be 4000
x 50= i.e., Rs. 2,00,000/-. The investors can also place orders by entering
value of MCX portfolio to be brought or sold with a minimum value of Rs.
50,000/- for each order.
PROCEDURE OF TRADING
1. Selection of broker
* Act with due skill, Care and diligence in the conduct of all his business.
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2. Opening an account with the broker
The next step to open account with the broker. It helps the investor to
provide his credit worthiness, if the clients were not to do margin money with
the broker.
3. Selection of securities
This is important to get the best advantage from buying or selling the
securities.
5. Placing an order
Various method of placing an order with the broker has been evolved
to give the broker leverage when he is on the floor of the stock exchange.
SEBI circular of 4th Feb. 1991 requires that all members of the
recognized stock exchange, issue contract note to the investors on the
execution of trade. Brokers, therefore issue contract note to the client, which
gives the name of the company, price of trade, brokerage, time of execution,
provision regarding arbitration etc. in term of the bye-laws of stock exchange,
this is statutory requirement and mandatory.
7. Settlement
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CONCEPT OF THE STUDY
DERIVATIVES
DERIVATIVE DEFINITION
The price of this derivative is driven by the spot price of wheat which
is the “underlying”. In the Indian context the Securities Contracts (Regulation)
Act, 1956 [SC( R) A] defines derivative to include
2. A contract, which derives its value from the prices or index of price of
underlying securities.
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ORIGIN OF DERIVATIVES
15
INDEX
MCX FUTURES
16
TABLE NO: 1
Source: www.mcx.com
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FUTURES
5. Location of settlement
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CHART NO: 2
ROLE OF CONTRACT
Money
Money
Asset Asset
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MARGINS
When you execute a futures trade, you have to provide the initial
margin, as is fixed by the exchange. The margin, consisting of cash or cash
equivalents, is to ensure that traders will honor.
TRADING CYCLE
EXPIRY DATE
FUTURES CONRACT
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TYPES OF HEDGING
Basically there are two types of hedging with futures. Long term hedge
and short term hedge.
In a long term hedge one buys futures contract. The hedger is either
currently short the cash good or has a future commitment to buy the good at
the spot price that will exist at a later date. By buying futures contracts any
subsequent price rise would lead to profit in the futures market and losses in
the cash market. The hedger must also be aware that prices might fail leading
to a profit in the cash market and loss in the future market. The hedger must
thus be reasonably sure that price changes of the cash position and changes in
the futures prices will be correlated.
In a short term hedge one sells futures contracts. The hedger fears that
prices will fall and if they do, loss will be sustained in the spot market. The
short edger either currently long the cash or as commitment to sell it on a
future date at a unknown price. If prices do indeed decline loss will be
incurred on the cash position but there will be a profit in the futures position.
As a result any loss that arising from cash position can be minimized by way
of hedging.
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HEDGING STRATEGIES
1) Have
portfolio, short MCX futures
2) Have funds,
long MCX futures
3) Short
security, long MCX future
4) Long
security, sort MCX future
RISK MANAGEMENT
REVIEW OF LITERATURE
Kamara (1982) compared cash market volatility before and after the
introduction of futures trading and found that the introduction of commodity
futures trading generally reduced or at least did not increase cash price
volatility.
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markets using the multiplicative dummy variable model and concluded that
futures trading has reduced the price volatility in the Hessian cash market.
Slade and thille (2004) assessed the levels and volatilities (means and
standard deviations) of the spot prices of the six commodities that were traded
on the London Metal Exchanges in the 1990s.The theories that they examined
could be grouped into four classes. The first considered how product-market
structure and forward-market trading jointly affect the spot-market game, the
second explored the links between product-market structure and spot price
stability, the assessed whether forward trading destabilizes spot prices, and the
last related the arrival of new information to price volatility and the volume of
trade. They found support for traditional market-structure models of the price
level but not of price stability. In addition, increased forward trading was
associated with lower prices. Further, although they found a positive
relationship between increased trading and price instability, the link appeared
to be indirect via a common causal factor.
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dollar but supported by the supply and demand, expectation of rising interest
by the US federal government and some geopolitical factors also.
Niteen jain says with the world becoming increasingly globalised and
there by resulting in intensified competition, it has become imperative to
control the cost as well as ascertain the bottom lines to remain spirited in the
market. The volatility in the commodities market has the potential to derail the
best of the strategies of the participants of commodity value chain. Global
supply demand imbalances in commodities and resulting price volatility will
likely continue to impact the profitability and competitiveness of the
participants. The only remedy that has the potential to provide an insurance
cover from this volatility is the effective use of derivatives.
In another study jayanta Kumar seal says, India is one of the leading
countries in the production of commodities. It is also having a long history of
derivative trading. The market has made considerable progress in terms of
technology, governance and trading activity. The most noticeable part is that
this development has taken place once the government has withdrawn the
protection from many commodities and allowed the market to determine the
price. Therefore, the price risk management should be handled by the market
forces and there should be no administered price mechanism. Management of
price risk will be very important once the free trade policy is introduced.
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Volatility is one of the most important factors when pricing options are
considered. The pricing of options depends on volatility of the underlying
asset. The price of a call or a put option is directly related to the volatility of
the underlying stock. The variables that appear in the black scholes differential
equation for pricing options are;
• Time
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1.2 COMPANY PROFILE
• The company is part of India Infoline Group. It has pan- India presence
through its distribution network of 607 branches, 151 franchisees located in 346
cities. The company also has presence in Dubai, New York and Singapore.
• The India Infoline group, comprising the holding company, India infoline
limited and its wholly-owned subsidiaries, straddle the entire financial services
space with offerings ranging from equity research, equities and derivatives
trading, commodities trading, portfolio management services, mutual funds, life
insurance, fixed deposits, goi bonds and other small savings instruments to loan
products and investment banking.
AWARDS
• India Infoline has been awarded the ‘Best Broker in India’ by Finance Asia.
Company’s Rs. 5 billion short-term debt programme has received an A1+ rating
from ICRA. This reflects highest -credit-quality of short-term debt instruments.
OUTLOOK
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• India Infoline has received approval from SEBI for sponsoring mutual fund.
Through this, the company wants to expand its product offerings.
MANAGEMENT TEAM:
• Nirmal Jain
• R Venkataraman
Executive Director,
• Nilesh Vikamsey
Independent Director
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PRODUCTS PROFILE
Infoline Insurance Brokers. The company is the largest Corporate agent for
broking.
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SME financing, distribution of retail loan products, consumer finance
CHAPTER – 2
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material, processors of commodities, importers, exporters,
traders, and so on.
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2.2 OBJECTIVES OF THE STUDY
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2.3 SCOPE OF THE STUDY
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2.4RESEARCH METHODOLOGY
RESEARCH PROBLEM
RESEARCH DESIGN
The formidable problem that follows the task of defining the research
problem is preparation of the design of the research project, popularly known
as “research design”. A research design is the arrangement of condition and
analysis of data in a manner that aims to combine relevance to the research
purpose with economy in procedure. It is empirical in nature. The aim is to test
how effectively the index future used to reduce the risk associated with the
index fluctuations while making an investment in the cash market by a
prospective investor, while is formerly known as hedging. This type of
research adopted for the project work is historical, descriptive and analytical in
nature.
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The study is purely based on secondary data collected from journals,
books and websites, along with the inside discussion with the trade participant
and authorized brokers in the year 2010. Already established hedging
strategies in this futures and options have been identified and were applied in
the data collection from various secondary sources.
• While applying the strategy transaction cost and impact cost are not
taken into consideration.
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CHAPTER-3
After data have been collected, it was then recorded, tabulated and
edited accurately. Data analysis was done with the help of computer to provide
accuracy and clarity. Share prices, prices of stock future and prices of MCX
futures are collected for a period from first January 1st to July 2010. For MCX
future prices are taken. Data collected from secondary sources and data
derives from the application of the strategies are analyzed using simple
statistical tools.
1. Continuous hedging
2. Descriptive hedging
SAMPLE PLAN
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COMMODITIES TAKEN
1. Gold
2. Silver
3. Platinum
4. Palladium
PORTFOLIO BUILDUP
The portfolio has been buildup with five major industries in present
scenario. Since the study is to find out the hedging effectiveness, the portfolio
was created in such a way that the beta of the portfolio is between 0.05 and
1.50
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TABLE NO: 2
1 GOLD 0.8994
2 SILVER 0.628
3 PLATINUM 1.3125
4 PALLADIUM 0.1555
37
The overall analysis of the study is subdivided into two parts;
Credibility of promoters.
ASSUMPTIONS OF HEDGING
There is no margin
No brokerage
Plenty of liquidity
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TABLE NO: 3
&
HEDGED AMOUNT
Value of BetaAmount
Beta of the Portfolio = Value of Portfolio
169317
=
174317
= 0.97
39
= Portfolio Amt x Portfolio Beta
= 174317x0.97
= 169087.49
169087.49
=
2865
= 59.02
= 286500
TABLE NO: 4
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Spot Lot
Date Commodity Amount Total P/L
price size
01.06.10 Gold 1227.75 1 1227.75
Silver 18.3 1 18.3
Platinum 1550 1 1550
Palladium 457 1 457 3253.05 0
41
Silver 18.31 1 18.31
Platinum 1539 1 1539
Palladium 449 1 449 3226.31 10.83
42
Platinum 1575 1 1575
Palladium 485 1 485 3305.41 -21.215
24.06.10 Gold 1236.25 1 1236.25
Silver 18.38 1 18.38
Platinum 1549 1 1549
Palladium 466 1 466 3269.63 -35.78
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06.07.10 Gold 1195 1 1195
Silver 17.85 1 17.85
Platinum 1509 1 1509
Palladium 432 1 432 3153.85 -7
44
Platinum 1512 1 1512
Palladium 456 1 456 3175.5 -50.92
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CHART NO: 3
INTERPRETATION
The above chart showing the daily price changes of portfolio. In the
beginning stage the portfolio was showing the upward movement so strategy
is buy the MCX future. After a few days the portfolio shows a downward
movement so here the strategy is sells the MCX future. At last again portfolio
shows the upward movement.
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TABLE NO: 5
CONTINUOUS HEDGING
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MCX HEDGE PROFIT/ NET
DATE PORTFOLIO PROFIT/LOSS FUTURE AMT LOSS P/L
01.06.1
0 3253.1 0 2865 286500 0 0
02.06.1
0 3225.4 -27.62 2858.35 285835 -665 -692.62
03.06.1
0 3260.3 34.84 2940 294000 8165 8199.84
04.06.1
0 3188.3 -72.01 2954.74 295474 1474 1401.99
07.06.1
0 3155.4 -32.9 2974.3 297430 1956 1923.1
08.06.1
0 3208.3 52.98 2960.6 296060 -1370 -1317
09.06.1
0 3241.8 33.43 3097.25 309725 13665 13698.4
10.06.1
0 3215.5 -26.29 3159.3 315930 6205 6178.71
11.06.1
0 3226.3 10.83 3058.1 305810 -10120 -10109
14.06.1
0 3255.2 28.87 3047.7 304770 -1040 -1011.1
15.06.1
0 3261.4 6.24 2777 277700 -27070 -27064
16.06.1
0 3292 30.59 2742.3 274230 -3470 -3439.4
17.06.1
0 3322.5 30.49 2751.15 275115 885 915.49
18.06.1
0 3336.8 14.27 2766.5 276650 1535 1549.27
21.06.1
0 3380.9 44.1 2986.1 298610 21960 22004.1
22.06.1
0 3326.6 -54.245 3070.75 307075 8465 8410.76
23.06.1
0 3305.4 -21.215 3081.5 308150 1075 1053.79
24.06.1
0 3269.6 -35.78 3079.7 307970 -180 -215.78
25.06.1
0 3299.7 30.02 3138.6 313860 5890 5920.02
28.06.1
0 3342.1 42.46 2310.85 231085 -82775 -82733
29.06.1
0 3261.1 -81.04 2446.95 244695 13610 13529
30.06.1
0 3240.7 -20.33 2469.25 246925 2230 2209.67
01.07.1 48
0 3200.2 -40.59 2290.1 229010 -17915 -17956
02.07.1
0 3160.5 -39.67 2093.95 209395 -19615 -19655
CHART NO: 4
Continuous Hedging
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INTERPRETATION
The above chart is showing the position of profit and the loss
occurred if the hedging strategy is not applied. From this chart we can see that
at the portfolio shows the fluctuating movements. Here the market is
uncertain and the chance for the profit and loss is equal. So it is better to
hedge the portfolio.
TABLE NO: 6
DESCRIPTIVE HEDGING
50
-
23.06.10 3305.4 21.215 3081.5 308150
24.06.10 3269.6 -35.78 3079.7 307970
25.06.10 3299.7 30.02 3138.6 313860
CHART NO: 5
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Descriptive Hedging
350000
300000
INTERPRETATION
The above chart is showing the daily changes in the heading amount.
Beginning stage hedging gives a more profit. However, after a few days it
was coming to down because of price changes in the stock market, in this time
hedging is not effective. At the end of the month again it goes up.
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DAILY PORTFOLIO ANALYSIS
JUNE
DATE PORTFOLIO
01.06.10 3253.1
02.06.10 3225.4
03.06.10 3260.3
04.06.10 3188.3
07.06.10 3155.4
08.06.10 3208.3
09.06.10 3241.8
10.06.10 3215.5
11.06.10 3226.3
14.06.10 3255.2
15.06.10 3261.4
16.06.10 3292
17.06.10 3322.5
18.06.10 3336.8
21.06.10 3380.9
22.06.10 3326.6
23.06.10 3305.4
24.06.10 3269.6
25.06.10 3299.7
28.06.10 3342.1
29.06.10 3261.1
30.06.10 3240.7
JULY
01.07.10 3200.2
02.07.10 3160.5
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05.07.10 3160.9
06.07.10 3153.9
07.07.10 3161.9
08.07.10 3186.5
09.07.10 3207.6
12.07.10 3205.6
13.07.10 3231
14.07.10 3213.3
15.07.10 3226.4
16.07.10 3175.5
19.07.10 3144.8
20.07.10 3140.6
CHART NO: 6
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Daily Portfolio Analysis
INTERPRETATION
Here chart shows the position of hedging through out the trading
period. And at the beginning stage the portfolio was in loss and also the
market shows a downward movement so the strategy was to sell the MCX
future. After a short day the market shows an upward movement so here we
change the strategy. That is here the strategy was to buy the MCX future. So
from the above chart we can see that the strategy was determined on the basis
of the market situation.
TABLE NO: 8
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DAILY ANALYSIS OF PORTFOLIO PROFIT/LOSS
JUNE
DATE PRIFIT/LOSS
01.06.10 0
02.06.10 -27.62
03.06.10 34.84
04.06.10 -72.01
07.06.10 -32.9
08.06.10 52.98
09.06.10 33.43
10.06.10 -26.29
11.06.10 10.83
14.06.10 28.87
15.06.10 6.24
16.06.10 30.59
17.06.10 30.49
18.06.10 14.27
21.06.10 44.1
22.06.10 -54.245
23.06.10 -21.215
24.06.10 -35.78
25.06.10 30.02
28.06.10 42.46
29.06.10 -81.04
30.06.10 -20.33
JULY
01.07.10 -40.59
02.07.10 -39.67
56
05.07.10 0.37
06.07.10 -7
07.07.10 8.05
08.07.10 24.6
09.07.10 21.12
12.07.10 -2.06
13.07.10 25.44
14.07.10 -17.71
15.07.10 13.13
16.07.10 -50.92
19.07.10 -30.72
20.07.10 -4.23
CHART NO: 7
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INTERPRETATION
Here the chat shows the two positions that is profit and loss before and
after the hedging. This lines one shows the position of profit and loss
occurred if the hedging strategy is not applied. And another one shows the
position of profit and loss incurred after the hedging. And from the above
chart we can understand that we can earn more profit through the descriptive
hedging strategy.
CHAPTER-4
58
&
CONCLUSION
4.1FINDINGS
1. From the above study, descriptive hedging is the optimum strategy for
hedging, because it minimizes loss when the market is down and
maximize profit when the market is boom.
3. When the market volatility at the time of the beginning stage of the
trade investors use descriptive hedging strategy to reduce the risk of
loss.
4. From the above study, the commodity market is always changing and
they cannot predict anything in the market, because of the different
kinds of market trends and situations. So they have to use optimum
hedging strategy to reduce the risk of loss in the volatility share
market.
5. From the above study, the risk factor cannot be avoided but it can be
minimized. The best that can be achieved using hedging is the
removal of an unwanted exposure.
6. The study reveals that an aggressive hedger can reduced the risk
through the adoption of suitable period and security. The expert make
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and aggressive decisions on the basis of the market performances and
this will help to reduce risk and maximize profit.
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4.2 SUGGESTIONS
2. Understand that the hedging is a tool to curtail the losses that may arise
from the market risk. Its primary objectives is not profit maximization,
but risk minimization. Any profit from shares or futures will be offset
from the losses from futures of shares as the case may be. As a result a
hedger will return comparing to that of an uneager.
3. The success of the hedge entirely depends on the trend and the
hedger’s ability in understanding the directing of the market trend. So
the hedger must have a better understanding of the market. Otherwise
hedge will result in a loss to the hedger.
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4.3 CONCLUSION
Hedging does not remove losses. The best one can be achieved
using hedging is the removal of unwanted exposure i.e. unnecessary risk. The
hedged position will make less profit than the unhedged position. Once
should not enter into a hedging strategy hoping to make excess profit for sure;
all that come out of hedging is reduced risk.
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