Contingent Hedging: Applying Financial Portfolio Theory on Product Portfolios
Independent thesis Basic level (degree of Bachelor), 10 credits / 15 HE creditsStudent thesis
In an ever-changing global environment, the ability to adapt to the current economic climate is essential for a company to prosper and survive. Numerous previous re- search state that better risk management and low overall risks will lead to a higher firm value. The purpose of this study is to examine if portfolio theory, made for fi- nancial portfolios, can be used to compose product portfolios in order to minimize risk and optimize returns.
The term contingent hedge is defined as an optimal portfolio that can be identified today, that in the future will yield a stable stream of returns at a low level of risk. For companies that might engage in costly hedging activities on the futures market, the benefits of creat- ing a contingent hedge are several. These include creating an optimized portfolio that minimizes risk and avoid trading contracts on futures markets that would incur hefty transaction costs and risks.
Using quantitative financial models, product portfolio compositions are generated and compared with the returns and risks profile of individual commodities, as well as the actual product portfolio compositions of publicly traded mining companies. Us- ing Modern Portfolio Theory an efficient frontier is generated, yielding two inde- pendent portfolios, the minimum risk portfolio and the tangency portfolio. The Black-Litterman model is also used to generate yet another portfolio using a Bayesian approach. The portfolios are generated by historic time-series data and compared with the actual future development of commodities; the portfolios are then analyzed and compared. The results indicate that the minimum risk portfolio provides a signif- icantly lower risk than the compositions of all mining companies in the study, as well as the risks of individual commodities. This in turn will lead to several benefits for company management and the firm’s shareholders that are discussed throughout the study. However, as for a return-optimizing portfolio, no significant results can be found.
Furthermore, the analysis suggests a series of improvements that could potentially yield an even greater result. The recommendation is that mining companies can use the methods discussed throughout this study as a way to generate a costless contin- gent hedge, rather than engage in hedging activities on futures markets.
Place, publisher, year, edition, pages
2012. , 44 p.
Finance, Modern Portfolio Theory, Product Portfolios, Black-Litterman, Efficient Frontier, Investment Decisions, Commodities, Hedging, Risk Management, Contingent Hedge, Diversification, Risk Minimization, Return Optimization, Mining, Metals
IdentifiersURN: urn:nbn:se:hj:diva-18602OAI: oai:DiVA.org:hj-18602DiVA: diva2:536260
Subject / course
IHH, Business Administration
UppsokSocial and Behavioural Science, Law
Eklund, Johan, Assistant ProfessorHögberg, Andreas, PhD