Forgive if this is a naive question. In the chapter ‘single asset concentrated portfolios’ there are many references to putting in place perfect hedges to take away risk. So if stock holding increases x%, your hedge decreases by the same amount. Net effect = 0. And vice versa.
Why in these situations would you bother to enter into a hedge of this sort - wouldnt it be less hassle to just liquidate to cash and keep in a bank until ready to enter market again?
A perfect hedge (which is mostly theoretical) would generally be to eliminate a short term risk. Buying an option for a short term period would require less effort than liquidating the position then re-entering it. The position could also be illiquid.
Usually hedges would be used to eliminate a specific risk and not all risk. You’ll also see in further readings about rebalancing hedges, and the cost benefit trade off.
As a general tip, sometimes CFAI taught material is theoretical and not how the real world works. Don’t get bogged down on it too much. Focus on what CFAI is teaching, that’s what they expect on the exam.
Thanks Cheswick
I remember that the reasons were fairly well covered in the curriculum. Some reasons that come to mind:
– You may not be able to liquidate due to legal/contractual/other restrictions
– The costs of exiting and re-entering could be prohibitive, especially relative to a buying a hedge
– You want to retain control or voting rights provided by the large position
I’d also add that funds typically have minimum cash invested guideline. No investor would pay 1% management fee if half your money is in cash.