Series 3: 2.2.1.2.2. Cross Hedge

2.2.1.2.2. Cross Hedge

A direct hedge is not always possible. A futures market does not exist for all cash instruments. We already know it no longer exists for Treasury bills. Nor can a company that issues or borrows commercial paper hedge its risk with a commercial paper futures contract. The interest rate charged for borrowing commercial paper is not tied to LIBOR. The lender or borrower must find and select some closely related instrument, such as Eurodollars, to hedge its interest rate risk.

Cross hedging is the use of a futures contract for the delivery of one security to hedge an anticipated future transaction in a different security. Cross hedges carry more basis risk than a direct hedge. Hedgers must look for a cross hedge that carries the least amount of basis risk. They must find the futures