Page 127 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes (v) The client then deposits the initial margin with a member firm of the clearing house.
(vi) The commission broker can transact in the pit with another commission broker
representing another client or with a local.

Self Assessment

State whether the following statements are true or false:
5. Each trader is required to post a margin to insure the clearing house against credit risk.
6. All-or-none-order stipulates to buy or sell at a specific price or better.
7. Fill-or-kill order instructs the commission broker to fill an order immediately at a specified
price.
8. Limit order allows the commission broker to fill part of an order at a specified price and
remainder at another price.
9. On-the-open or on-the-close order represents orders to trade within a few minutes of
operating or closing.

8.3 Application of Futures

Passive Management: Index Fund

Futures are very convenient in constructing a portfolio. Let us assume that we wish to structure
an index fund of $10 million and that the current price of the S&P 500 future is $500. Each contract
is, therefore, equivalent to a common stock exposure of 500 times $500, or $ 2,50,000. To gain an
exposure of $ 10 million in common stocks, one could easily and quickly purchase 40 S&P 500
futures contracts. Its advantages are:

Lower transaction costs
Higher liquidity in futures markets
Portfolio construction via futures market offers the advantage of actually buying the
index
No dividends to reinvest.

General Strategy: Deposits to Portfolio

A second application of futures involves cash contributions (withdrawals) or a large deposit to
an existing portfolio. Buying additional common stock with a sudden large cash inflow may
take time – time during which one is exposed to significant market moves.
Stock index futures offer an alternative. Let us assume that on day one $50 million is deposited
to the portfolio. This deposit could immediately be invested in the stock market and the desired
stock market exposure 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.

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