Page 128 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 8: Currency Futures and Currency Options

Notes

Notes Futures can be used in a similar fashion to manage portfolio withdrawals, although
in the opposite way.

Beta Control

The third application involves implementing an active stock market judgement. 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.

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 judgements. 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.

8.3.1 Options vs Futures

Futures should be distinguished from options.
Gains and losses on open futures positions are limited only by the price of the underlying
securities. Gains on an option are virtually unlimited for the purchaser (subject to the movement
of the underlying stock) but limited to the option premium for the writer. Losses, on the other
hand, are virtually unlimited for the writer but limited to the premium for the purchaser.
Hedging can be accomplished with either options or futures. But a single futures position can
neutralise exposure in the underlying asset. Accomplishing the same hedge with options requires
simultaneous put and call options in separate markets.
On the other hand, options possess characteristics that cannot be effectively simulated by positions
in the futures market. In particular, the option purchaser can insure against a decline in the value
of the underlying assets while the option writer can generate income over and above the stock’s
dividend yield (or bond’s coupon).
Problem 1:

Suppose that an importer has to make a payment of £10 million due in 90 days.
(a) If the 9-day pound forward rate is $1.5201, what is the hedged cost of making that payment?

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