Identifier: C3T5L4 · Revision: 2026-10-26 · Classification: domestic

Decision and objectives

Diagnose basis, leg, liquidity and funding failures separately. The decision record must connect the exposure, cash dates and implementable contract, rather than stop at a favorable price forecast.

By the end, you can diagnose basis, leg, liquidity and funding failures separately; reconcile a failed hedge using actual fills; set an exit plan that acknowledges gaps and partial execution.

Prerequisite: C3T5L3; completed Classes 1 and 2 and the Stock Market School foundation or Forex School foundation. All cases below are hypothetical; their prices, costs, rates, dates, contractual assumptions and collateral amounts are teaching inputs, not current offers.

Mechanics

A hedge can fail economically, operationally or both. Basis failure means the hedge reference moved differently from the exposure. Leg failure means the intended offset was absent or delayed. Liquidity failure means an acceptable exit was unavailable. Funding failure means cash was missing before eventual economic offset. Naming the failure determines whether changing quantity, instrument, execution method or cash reserve addresses it.

Price and return drivers

Realized package result uses actual asset proceeds plus actual derivative settlements less acquisition value and every charge. A model mark can diagnose sensitivity but cannot replace an unavailable execution. Keep target and filled quantities in separate columns and reconcile a residual position after every partial close.

Worked case

Hypothetical equity portfolio starts TRY 1,000,000 and a short index hedge represents TRY 1,000,000. Asset falls 8%, losing TRY 80,000; hedge reference falls 5%, gaining TRY 50,000 at the model mark. Indicated residual −TRY 30,000. Actual futures close suffers TRY 4,000 slippage; commissions TRY 1,000 and funding TRY 2,000 leave realized package −TRY 37,000 before tax. The TRY 7,000 difference from model residual is an identifiable execution and financing cost, not beta error.

Adverse case

If only 60% of the short closes, 40% remains: reference notional TRY 400,000 at the stated basis. A subsequent 6% rise loses approximately TRY 24,000 on that remaining short, even if the cash portfolio has already been sold. A forced sale of collateral to pay this loss may add another spread and settlement lag. A limit order can protect a price boundary while failing to execute; no order type guarantees both execution and price through a gap.

Practical use

Before entry define a cash reserve, acceptable residual, leg sequence, maximum unpaired duration and whom to contact if settlement or trading fails. Check member risk rules and price limits. Log actual fills, cancellation acknowledgements and bank transfers. Include emergency financing, custody transfers, roll/termination charges and taxes; a general warning cannot substitute for this product-specific response.

Reconcile the confirmation, position register and cash statement separately. Costs include the quoted bid/ask spread, brokerage and clearing charges, collateral or principal financing, currency conversion, custody where relevant, and exit or termination charges. A mark is not a fill. Any amount explicitly excluded below remains outside the reported result. Tax is excluded from these teaching cases: an actual comparison requires income year, investor residence and individual/corporate status, contract and acquisition dates, settlement form and effective law. The GIB guide, checked 2026-10-26, covers 2025 individual investment income, so its publication date alone does not settle a 2026 derivative liability.

Decision boundaries

Diagnose the source before increasing hedge size: more contracts can magnify a basis or leg problem. A smaller cash position may be more robust when derivatives cannot be exited or funded. A written decision to leave part unhedged is preferable to claiming protection from orders that never executed.

Practice and references

Exercise: hypothetical asset loss TRY 45,000; mark-based hedge gain before slippage TRY 32,000; slippage TRY 1,500, fees TRY 500 and funding TRY 1,000. Calculate package result and stress a remaining TRY 200,000 short after asset sale. Solution: −45,000 + 32,000 − 1,500 − 500 − 1,000 = −TRY 16,000. If TRY 200,000 short exposure remains after selling the asset, a 4% reference rise adds about TRY 8,000 loss. The latter is a new naked residual, not protection.

Takeaway: Set an exit plan that acknowledges gaps and partial execution using the actual cash schedule, with every excluded cost and remaining exposure stated.

Reference card: viop-future. Formula: Realized hedge package result. Glossary: Basis risk, Liquidity gap. Next lesson: C3T6L1. Topic test.

Sources and verification date (2026-10-26):

Shared reference guide | Class examination