# Using Financial Instruments to Transfer the Information Security Risks
## 7 Demonstration: An Example Application
### Information Security Vanilla Options
#### 7.2.4 Risk Hedging
\[\alpha_{m}=(\rho_{s_{1}}*\mu_{u_{1}})+(\rho_{s_{2}}*\mu_{u_{2}})+(\rho_{s_{3}}* \mu_{u_{3}}) \tag{39}\]  
where, \(\alpha_{\rm m}\) is the market's expected future value (unhedged), \(\rho_{\rm s_{1}}\) is the probability of \(s_{1}\), \(\mu_{\rm u_{1}}\) is the impact value (unhedged) for state 1, \(\rho_{\rm s_{2}}\) is the probability of \(s_{2}\), \(\mu_{\rm u_{2}}\) is the impact value (unhedged) for state 2, \(\rho_{\rm s_{3}}\) is the probability of \(s_{3}\), and \(\mu_{\rm u_{3}}\) is the impact value (unhedged) for state 3. The expected future value from the market's perspective in an unhedged scenario is shown in Figure 11, and calculated as shown in Equation (40). \[\alpha_{m}=(60\%*0)+(30\%*(-\$10,000))+(10\%*(-\$30,000))=-\$6000 \tag{40}\]  
Based on the company's risk estimate the expected future value in an unhedged scenario can be calculated as shown in Equation (41). \[\alpha_{c}=(\rho_{s_{1}}*\mu_{u_{1}})+(\rho_{s_{2}}*\mu_{u_{2}})+(\rho_{s_{3}}* \mu_{u_{3}}) \tag{41}\]  
where, \(\alpha_{\rm c}\) is the company's expected future value (Unhedged), \(\rho_{\rm s_{1}}\) is the probability of \(s_{1}\), \(\mu_{\rm u_{1}}\) is the impact value (unhedged) for state 1, \(\rho_{\rm s_{2}}\) is the probability of \(s_{2}\), \(\mu_{\rm u_{2}}\) is the impact value (unhedged) for state 2, \(\rho_{\rm s_{3}}\) is the probability of \(s_{3}\), and \(\mu_{\rm u_{3}}\) is the impact value (unhedged) for state 3. Figure 11: Unhedged Expected Future Value for Market’s Probability Estimate. The expected future value from the company's perspective in an unhedged scenario is shown in Figure 12, and calculated as shown in Equation (42). \[\alpha_{c}=(50\%*0)+(30\%*(-\$10,000))+(20\%*(-\$30,000))=-\$9000 \tag{42}\]  
Thus, if the company remains unhedged then it would suffer a significant loss if the ISVO underlying information security event occurs. (2.2) Hedged Scenario  
If the company decides to hedge its maximum risk exposure of $30,000, then the first step is to determine the number of ISVO contracts that are required to perfectly hedge the risk exposure. We use the Equation (28) to calculate the required number of ISVO contracts. Thus, to perfectly hedge the risk exposure of $30,000, number of ISVO contracts required are computed in Equation (43). \[(\text{For a perfect hedge, hedge ratio is 1})=>1=\frac{(\omega*100*3)-0}{30,000} \tag{43}\]  
For the sake of clarity and simple demonstration, we ignore the cost of transaction and the Equation (44) gives the number of ISVO contracts required to hedge $30,000 loss.  
\[\omega=100 \tag{44}\]  
Thus, the hedger would pay $3000 to purchase 100 ISVO contracts at the rate of $30 per option and the contract pays $030,000+\$30 per option and the contract pays $130,000)}{(\$30 per option and the contract pays $23000)} \right)*100=90.91\% \tag{45}\]  
Therefore, the above hedge strategy with ISVO is expected to be 90.91% effective in mitigating the underlying information security risk. In a perfectly hedged scenario the expected future value from the market's perspective can be calculated as shown in Equation (46). $30 per option and the contract pays $3  
$30 per option and the contract pays $4 Unhedged Expected Future Value for Company’s Probability Estimate. where, \(\beta_{m}\) is the market's expected future value (hedged), \(\rho_{s_{1}}\) is the probability of \(s_{1}\), \(\mu_{h_{1}}\) is the impact value (hedged) for state 1, \(\rho_{s_{2}}\) is the probability of \(s_{2}\), \(\mu_{h_{2}}\) is the impact value (hedged) for state 2, \(\rho_{s_{3}}\) is the probability of \(s_{3}\), and \(\mu_{h_{3}}\) is the impact value (hedged) for state 3. The expected future value from the market's perspective in a hedged scenario is shown in Figure 13, and calculated as shown in Equation (47). $30 per option and the contract pays $5  
\(\bullet\)\(\mu_{h_{1}}=\$30 per option and the contract pays $63000\) cost to buy 100 ISVO contracts.