By Stephen A. Keen and Andrew P. Cross
This post continues our examination of the “10% buffer” for Hedging Derivatives, which refers to the amount by which the notional amounts of Hedging Derivatives can exceed the value of hedged equity investments, par amount of hedged fixed-income investments or principal amount of hedged borrowings. In this post we examine what it means for Hedging Derivatives to exceed the 10% buffer.
Application of the 10% Buffer
The 10% buffer is intended to address:
situations, such as shareholder redemptions or fluctuations in the market value of a hedged investment, that can temporarily cause the notional amounts of the hedges to exceed the value of the hedged investments by more than a negligible amount.”
avoid funds frequently trading (and incurring the attendant costs) to resize their hedges in response to small changes in value of the hedged investments.”
Consider, for example, a Limited Derivatives User holding euro denominated equity investments with a current value of €10 million that enters into 80 of the September 2022 Euro FX Futures to sell a total of €10 million for a total of $11,908,000. What would the consequences under Rule 18f-4 be if, a month later, the value of the equity investments has fallen to €9 million?
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