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hi sir
can you please explain why do we have to calculate under and over hedge and what does this figure mean?
i saw your lectures but there when you were solving the exercises you didnt use such terms.
but as i recall you did explain what a perfect hedge was and reasons for when there isnt a perfect hedge .hence by over/under hedge does it mean that when the “net amount” is different than the “Return point”?
In terms of getting the marks, it is a minor point.
It is simply that because with futures and options the deal has to be in fixed size contracts, then the amount hedged is unlikely to be exactly the same as the amount of the actual transaction. Therefore they will end up hedging a bit too much or a bit too little.
The amount of the over or under hedge is therefore still at risk of exchange rate movements (although this could be eliminated by using a forward rate on the amount).
Hi sir,
(June 2014 Q1 option contracts)
For exercise price US$1.06/CHF1, 38.19 put contracts needed, so we purchase 38 contracts meaning there will be amount not hedged. However, for exercise price US$1.07/CHF1, 37.83 put contracts needed, but 38 contracts are purchased meaning there will be amount over-hedged. When do we apply under-hedge or over-hedge? Or, it does not matter and I can calculate “amount not hedged” for both exercise prices?
Thank you
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