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GFXC sees no changes to code on pre-hedging
Committee rejects calls to set more strict boundaries to controversial practice Print this page
The Global Foreign Exchange Committee (GFXC) pushed back against market participants’ call for change to the pre-hedging principle contained in the FX Global Code, all but killing their hopes to see some detailed guidance around the practice.
“The essence of the code is principles-based, it’s not prescriptive and it’s not regulatory. Therefore, the point is not to nail down a particular size at which pre-hedging suddenly becomes more appropriate, but instead to talk about how the market should
HOW DOES ONE HEDGE WITH FUTURES?
For hedging using futures, the hedger can take a position in the futures market and lock-in prices. For instance, a cotton farmer who faces the risk of fall in price after harvest, can hedge by selling cotton futures much ahead of harvest. The prevailing price at which he enters the market will become the effective price irrespective of which way the price moves later. Similarly, a copper procuring firm, facing the risk of a possible rise in prices, can hedge by buying copper futures and locking-in the metal’s effective price. In each case, the hedger can exit the market by either actually selling/ buying the commodity in/from the exchange-accredited warehouse, or financially settling by taking the reverse position. Whatever be the choice, the hedger’s effective price is locked-in at the time he entered the futures market.
Risk.net
Insurance quants increase risk-adjusted profits using novel hedging technique
But there is no standard way for insurance companies to hedge the risk of variable annuity contracts.
Two industry practitioners have put forward a new hedging method using protective put options. They estimate that the technique can improve risk-adjusted profits for insurers’ variable annuity portfolios by 60%.
The improvement comes from two sources: more efficient use of options as a hedging tool, and a reduction in the capital charges for insurers.
The approach is based on the assumption that a variable annuity can technically be seen as an option on the future value of the premiums. “The liabilities can be modelled as long-dated options and we use short-dated put options to hedge them. And we are framing how to calculate that hedge and optimise capital requirements,” explains Vivek Shah, who oversees investment and hedging solutions at Prudential plc in London. Shah co-authored the r