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Transcript. If I were you, I'd pay attention to the numbers.
There are two primary reasons to hedge. One is to read
reduce your short-term cash flow volatility. Another is to maximize return on
capital for whatever the investors target level of risk is. Many benefits are
achieved if you successfully reduce cashflow volatility, the primary one being
that nine times out of 10, the risk of bankruptcy bank raptly can be reduced,
which not only reduces the cost of borrowing but also makes lenders more
willing to lend you any money to begin with. Furthermore, more accurate
earnings forecasting is possible when hedging a company with more predictable
earnings will in general be more valued by investors. If your company uses
hedging to withstand short term price movements, its management can then focus
their energy more focus more fully on the company's core competencies, doing
what they are best at. In 1997, a poll was done suggesting that 1700 people
currently hedging against price fluctuations feel that in some ways, it's a lot
like gambling. But that's not true at all. Gambling increases one's risk
profile by making a bet on price movements. By hedging, you're doing the exact
opposite, you're reducing the risk profile of your organization. So don't have
some preconceived notion that the odds are somehow in your favor. Although some
people are willing to ignore market movements and think that they're think
they're making a safe choice. By doing so they've actually chosen to turn a
blind eye to market volatility, so it's not at all a safe choice. Another thing
worth mentioning is options.
Speaker 2 [ 00:02:01]
You can think of options as a kind of insurance against the
price of a share in a company moving either up or down. And just like you would
with regular insurance, an upfront premium payment needs to be paid to the seller
of the option. Though it's important to remember that an option gives you the
option hence the name, but not the obligation to buy or sell a share at a set
price in the in the future. options can be priced using a variety of different
mathematical models, the Black Scholes being the most common one. This model
uses several assumptions about market behavior when pricing an option. For
example, the ability to continuously hedge an option position. Even though this
assumption makes sense. In theory, it's not that realistic in a real-world
scenario. However, it's still one of the most popular models used by traders.
Even Trader Joe, its frequent use, largely explained in that it provides a
quick closed form solution. What other methods of pricing options such as Monte
Carlo simulations require you to test a million of possible different
scenarios? Did you know that in casinos, the probability of a sequence of
either red or black occurring 26 times in a row is around one in 66 Point 6
million I didn't, which is probably why I lose an average of 50 bucks a month
of the track. If you're a trader carrying a plethora of different options in
your portfolio, Monte Carlo, or Santa Anita simulations can could require
enormous brute force computing power to carry out which in a lot of cases takes
more time than is reasonable for you to spare.
Speaker 1 [ 00:04:00]
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