ABSTRACT

A derivative is an instrument whose value depends on the value of other underlying variables and its basic object is to manage the risk and not to gain the profit. There are mainly four types of derivative: (1) Forward Contracts (2) Future Contracts (3) Options (4) Swaps

This research paper is mainly focused on Future contract which is a standardize contract in which party to a contract buy or sell an asset at a certain future time at an agreed price. There are two types of future contracts: (1) Financial Future Contracts (2) Commodity Future Contracts In this research paper we are focusing on financial future contracts.

The basic motivation for hedging is to reduce or eliminate the variability of profits and firm value that arises from market changes. The effectiveness of a hedge becomes relevant only in the event of significant change in the value of the hedged item. A hedge is effective if the price movements of the hedged item and the hedging derivative roughly offset each other. Hedging through trading futures is a process used to control or reduce the risk of adverse price movements. The introduction of

stock index futures contracts offer the market participants the opportunity to manage the market risk of their portfolios without changing the portfolios composition.

This research paper investigates the hedging effectiveness of the NIFYT stock index futures contract using monthly settlement prices for the period January 2011 to December 2011.

Particularly, it focuses on two areas of interest: (1) The determination of the appropriate model for estimating a hedge ratio that minimizes the variance of returns; (2) The hedging effectiveness and testability of optimal hedge ratios through time.

The results suggest the optimal hedge ratio that incorporates nonstationarity, long run equilibrium relationship and short run dynamics is reliable and useful for hedgers.

If R2 is greater than 50% than it is observed that optimal hedge ratio which is apply to a particular stock and gives best result.

RESEARCH METHODOLOGY

1. STATEMENT OF RESEARCH PROBLEM

EFFECTIVENESS OF HEDGING AND HEDGE RATIO ESTIMATION OF ABB Ltd. Hedging activity involves finding out of optimum hedge ratio and testing hedge ratios. Hedging through trading futures is a process by which adverse price movements can be controlled and reduced.

2. RESEARCH OBJECTIVES

Minimization of Market Risk through hedging in practical aspect.

To test the Effectiveness of Hedging by different models.

To find optimum hedge ratios.

3. TYPES OF RESEARCH: Secondary

4. COLLECTION OF DATA: www.nseindia.com

5. RESEARCH TECHNIQUE: Judgmental Sampling

DATA ANALYSIS & INTERPRETATION

Months January February March April May June July August September October November December

Spot Price 732.35 666.65 796.8 854.9 864.4 875.55 868.9 836.1 693.2 709.95 596.65 583.3

Next Month 736.35 662.1 776.45 850.7 866 870.6 868.7 833.05 697.05 712.5 593.1 580.75

Distant month 735.95 660.2 798.75 845.5 852 861.45 852 816 696.1 719.45 590.35 575.7

Solution:
Months January February March April May June July August September October November December Total S(Y) -65.7 130.15 58.1 9.5 11.15 -6.65 -32.8 -142.9 16.75 -113.3 -13.35 -149.05 F(X) -73.85 116.25 51.95 20.5 18.6 7.25 -18.95 -118.95 16.4 -126.35 -9.6 -116.75 X2 5453.8225 13514.0625 2698.8025 420.25 345.96 52.5625 359.1025 14149.1025 268.96 15964.3225 92.16 53319.1075 Y2 4316.49 16939.02 3375.61 90.25 124.3225 44.2225 1075.84 20420.41 280.5625 12836.89 178.2225 59681.84 xy -4851.95 -15129.9 -3018.3 -194.75 -207.39 48.2125 -621.56 -16998 -274.7 -14315.5 -128.16 -55691.9

R2 =

{ nxy (x)(y)}2 {nx2 (x)2} x {ny2 (y)2

= { 11(-55691.9) (-116.75)( -149.05)}2 {11(53319.1075) (-116.75)2} x {11(59681.84) (-149.05)2} = 0.97497306

= nxy (x)(y) nx2 (x)2 = 11(-55691.9) (-116.75)( -149.05) 11(53319.1075) (-116.75)2 = 1.03897866

= y n = -149.05 11 = - 13.55

= n

= -116.75 11 = -10.61363636

= -13.55 {-1.03897866 (-10.61363636)} = -2.522658358

Equation: Y= + X

= 2.52265836 + (1.03897866)x

CONCLUSION

SCOPE OF THE STUDY

A hedge using index futures removes the risk arising from market moves and leaves the hedger exposed only to the performance of the portfolio relative to the market.

Futures contracts enable market participants to alter risks, which they face caused by adverse and unexpected price changes.

Hedging through future market is advantageous because of its low cost. This study is useful for those who are risk averse and those who want to protect themselves from the risk arising from the unexpected market movements.

The study also focuses on the effectiveness of the hedged portfolio and tests its effectiveness. The return from the unhedged portfolio is exposed to unlimited market risk. However by hedging the portfolio with appropriate hedge ratios one can minimize the unexpected market moves.

REFERENCES

Website:
1. nseindia.com 2. yahoofinance.com

Book:
1. Futures & Options (By) : Vohra & Bagri