n order to effectively use the interest rate futures markets for hedging, two distinct types of hedges need to be recognized: One involves an existing position in the cash market; the other is where a cash position has not been taken but is expected to be taken in the future. The former situation may be called a cash hedge while the latter is known as an anticipatory hedge. An example of a cash hedge would be if one were worried about the possible decline in value of his financial assets due to increases in interest rates. In this case, an interest rate futures contract would be sold to offset such a decline in value. On the other hand, if one were anticipating the purchase of a financial asset, the concern would be that rates would fall, and the proper action would be to buy futures contracts.2 While hedging in the traditional commodity markets is conducted primarily to protect an actual position in the cash market, hedging in the financial markets may be most useful for anticipatory hedging; i.e., hedging the interest rate at which one will borrow or lend.
After briefly justifying our contention that anticipatory hedging is the more relevant type of hedge for the financial futures markets, we will then develop a model of anticipatory hedging with financial futures. Next, we will show that in the application of such a model, there may be some confusion about the proper rate to be hedged, and we will analyze the relative merits of alternative rates that might be used.
'The anticipatory hedge was officially recognized as a bona fide hedge in 1956 when it was defined in an amendment to the Commodity Exchange Act.
'Since an intended long position in the cash market implies that one hedge by purchasing a futures contract, it might be argued that this is actually a short cash position. In order to avoid confusion, hedges will be defined with respect to the futures market. Thus, a long hedge will involve buying a futures contract.