Where does the cash for hedging come from (and effective beta)?

[JSobes]

I know this may be a silly question, but when doing these calculations I’m just a little confused. If we own a $20mn portfolio and want to hedge by buying $1mn in NP of contrats, is that just an additional investment in futures contracts? Are we borrowing that money to execute the hedge? And in that case, wouldn’t the effective beta NOT be calculated by excluding the notional principal of the hedge? I guess since with futures we can do payment netting and not execute the contract until the valu changes that’s the reason we don’t include the notional principal?

 

[dwheats]

You don’t require any cash/equity the enter into a future/forward/swap (unless it is a currency swap). The NP is just the reference amount to which the interest is calculated.
In reality, you would likely be required to post collateral/margin to enter into a contract due to counterparty credit risk…but that is not part of the curriculum.
And effective beta is calculated as the return on your actual portfolio (including hedged positions), divided by the return to the becnhmark you are referencing (hedged to). So the NP is is used to calculate the numerator, but not the denominator