Hedging an Equity Portfolio Essay Example | Topics and Well Written Essays - 1750 words

Hedging an Equity Portfolio - Essay Example Cross hedging capabilities may depend on various factors. First is the degree in which the spot and futures currencies are negatively or positively correlated. Secondly, this also depends on the level of accuracy of the estimated risk-minimizing cross-hedge factors. In addition, time is an important factor in this process and therefore the capability of cross hedging depends on the stability of the optimal cross hedge proportions over a given duration or period of time. Moreover, this also depends on the potential risk reduction from portfolio cross-hedging. A hedger is any individual or institution that minimizes the variance of expected monetary returns on a currency spot position with regards to a position in the currency’s corresponding future contract. There are various reasons for hedging in a financial set up. First is for the purposes of managing volatility in cash flows. Secondly, hedging is important for the purposes of checking the market value of an organizationâ⠂¬â„¢s shares. Hedging is also used for the purposes of managing volatility in accounting earnings. In addition, the management of balance sheet accounts and ratios can also benefit from hedging. For fund managers, performance information with regards to their hedging activities should be provided without restrictions or resistance from the fund manager. This is because funds may avoid reporting because of poor results. Such funds usually have below average returns in comparison to other funds and in addition, omitting them may result in an upward bias. On the other hand, there might be other funds that have become very successful as a result of growth in areas that they may not have actually wished to attract new investments. These funds may also decide to leave the database for a very different reason. Tentatively, their performance is likely to be superior to that of the average fund. Whereas there might be difficulties in attaining accurate estimates of these two effects, it is believed that the reported returns are usually biased upwards. Secondly, hedge fund databases have a limitation of reporting data only on funds still in existence or those that are new and rapidly growing. Funds that are no longer active are usually eliminated from the database. This practice in turn leaves an upward bias to performance statistics. This is because funds that are closed are likely to be poorly performing. Another type of bias can be referred to as the instant history bias. This occurs when a fund is included on the database for the first time and is therefore permitted to backfill its historical records. This type of bias could be estimated through the calculation of the average of the returns since introduction and later comparing them to the average returns since the fund joined the database. There are different hedge fund styles that are applicable in the financial markets today. Generally, hedge funds are not strictly regulated investment components that engage the use of a wide range of