BFS Limited has agreed to underwrite a forthcoming equity issue (at $6.15 per share which is equal to the current market price) by Australian Foundation Limited (AFI), a Listed Investment Company on the ASX. Any shares acquired by BFS must be held by them for at least 28 days before they can be disposed of. It is currently the start of April and BFS expects that they will have to purchase around 1m shares of AFI in mid-April but will dispose of the shares on market as soon as they are permitted under the underwriting agreement.

Explain how BFS can hedge, using futures contracts, the risk associated with any equity it acquires through the underwriting agreement. Include a worked example in your explanation.

Answer rating: 100% (QA)

First of all we need to understand what is hedgingIn order to safeguard ourself from price fluctuati... View the full answer