Page 121 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes achieved by buying ` 50 million worth of futures contracts. Given the assumptions of the index
fund example, this could be accomplished by buying 200 contracts. These contracts can be sold
off as desired individual issues are purchased for the portfolio. Assume that such stock purchases
occur evenly over a ten day period from day two through day eleven. On each of these days, the
portfolio manager buys ` 5 million worth of attractive stocks and sells one tenth of the futures
contract position or approximately twenty eight contracts, the desired stock market exposure of
the portfolio is maintained at all points of time.
Futures can be used in a similar fashion to manage portfolio withdrawals, although in the
opposite way.

7.4.3 Beta Control

The third application involves implementing an active stock market judgment. Assume that a
portfolio manager having a positive outlook for the stock market wishes to raise the exposure
of a portfolio to market, i.e., wants to raise the beta of a portfolio. One way to move the portfolio
beta up is to sell a number of lower beta stocks and buy an equivalent amount of higher beta
stocks. The alternative approach would be to buy an appropriate amount of stock index futures.

The advantages of controlling beta by using stock index futures are:
 The target beta can be achieved almost immediately.

 The optimal stock mix is maintained.
7.4.4 Asset Allocation Strategy

A fourth futures application involves asset allocation. Assume that the manager of a large
portfolio wishes to change the stock bond mix to reflect new investment judgments. The strategy
can be implemented in two ways:

 The traditional way would be actually selling stocks in the market and buying bonds.
 The alternative way would be to use futures, i.e., selling the stock index futures and
buying the equivalent Treasury bond futures.

In addition to advantages of lower implementation costs and quicker implementation, the
alternative strategy causes minimum disruption and less money is required to alter the asset
mix due to leveraged nature of a futures market.

Self Assessment

State whether the following statements are true or false:
16. By locking in a price companies are able to eliminate the ambiguity having to do with
expected expenses and profits.
17. The most important of index futures are index futures based on broad market indexes such
as the S&P500 Futures and the Nikkei 225 futures.

18. All passive orders are stacked in the system in terms of price-time priority and trades take
place at the passive order price.
19. Individual stock futures contracts are cash settled on a T+2 basis.

20. One way to move the portfolio beta up is to sell a number of higher beta stocks and buy an
equivalent amount of lower beta stocks.

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