(i) Explain why the investor takes this hedging strategy. (2 marks)
(ii)How many contracts must the hedger use to have a precise hedge? Calculate the net profit/loss made due to the hedging.

Here are many empirical and fundamental reasons in favour of including hedge funds in an institutional investment portfolio, and the major ones are:
1)High returns and low volatility History has proved that the returns offered by hedge funds are similar to those produced by the major equity indices, while the risk, measured by the volatility of earnings, is closer to that expected from bond investment.

2)Low correlation One of the disadvantages of conventional fund management is the very high correlation of performance between funds. This means that in poor investment conditions all fund managers perform poorly, with the target merely to outperform the opposition rather than providing an absolute return for the investor. This high correlation means that there is not so much to choose between fund managers. Hedge funds exhibit precious little correlation between each other and with conventional investment funds. Hence they can perform well in all market conditions, irrespective of the performance of conventional funds.
3) Variation of risks The investment risks involved within a hedge fund are different from those encountered within the conventional market. The conventional fund manager brings the risk of falling markets; the size of this risk depends on the individual manager, but the risk is the same nevertheless. The hedge fund manager may bring this risk, to a certain extent, but it is greatly reduced, as he or she is not confined only to positive market exposure. The hedge fund manager brings greater risk of relative value, enhanced by the level of leverage taken. The necessity of having to rely on greater prediction of market direction, stock selection and relative value makes the job of the hedge fund manager more difficult.
4) More flexibility It should be of little surprise that the expected returns from a hedge fund should be better than for a conventional fund manager, given the same amount of risk taken. Simply, the conventional fund manager is confined to being long of the market with little use of derivatives and leverage allowed. The conventional fund manager would not expect to perform as well as a hedge fund manager of similar quality who is not similarly constrained.
5)Top quality managers As the skills involved in being a successful hedge fund manager are often considered greater than those needed by conventional fund managers, the rewards to attract the most talented individuals are often great.
6)Managers’ personal interest Unlike the conventional fund management industry, hedge fund managers are encouraged to have an amount of their own money invested in the funds they are managing. This is analogous to a bank that will not lend money to an entrepreneur unless the entrepreneur has a certain amount of their own capital tied up in the enterprise. Similarly, a hedge fund manager with cash involved in the fund has an increased incentive to perform well.

Hedge Ratio = Value of the Hedge Position/Value of the Total Exposure

Value of the Hedge Position = Total dollars which is invested by the investor in the hedged position.

Value of the total exposure = Total dollars, which is invested by the investor in the underlying asseth

For any Options trade, you need to specify the following:
1)Instrument
2)Expiry
3)Call or Put
4)Buy price
5)Sell price
6)Quantity
For example:
With Nifty, the lot size is 75. Therefore, if you’re trading 2 lots, you’re trading a quantity of 150.
Always keep in mind that you are buying and selling the Premium price.
Let’s take an example with Nifty Options. Assume I’m trading Nifty May 9500 Call with a quantity of 3 lots (quantity of 225).
Sell Price: 52.50
Buy Price: 50.00
Quantity: 225
Profit = Quantity x (Sell Price - Buy Price)
Profit = 225 x (52.5 - 50)
Profit = Rs. 562.5