R27 risk management applications of forward and futures strategies

Reading 27
Risk Management Applications of Forward
and Future Strategies
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Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute. Reproduced
and republished with permission from CFA Institute. All rights reserved.


Contents
1.
2.
3.
4.
5.
6.
7.

Introduction
Strategies and Applications for Managing Interest Rate Risk
Strategies and Applications for Managing Equity Market Risk
Asset Allocation with Futures
Strategies and Applications for Managing Foreign Currency Risk
Futures or Forwards
Final Comments

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1. Introduction

• Forwards
• Futures
• Arbitrage
• Hedging
• Managing Risk
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2. Managing Interest Rate Risk
Forward rate agreements (FRA)
Duration
Change in bond price and duration
Interest rate risk of bond futures contracts
Bond futures can be used to increase or
decrease duration of bond portfolio

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3. Strategies and Applications for Managing Equity
Market Risk
3.1 Measuring and Managing the Risk of Equities
3.2 Managing the Risk of an Equity Portfolio
3.3 Creating Equity out of Cash
3.4 Creating Cash out of Equity

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3.1 Measuring and Managing the Risk of Equities
We will use beta as our risk measure
Dollar Beta = beta x market value

We can use futures contracts to change the portfolio beta

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3.2 Managing the Risk of an Equity Portfolio
2 September

Why is N positive?
What is the risk?
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Scenario on 3 December

Is the same as the target beta?

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3.3 Creating Equity out of Cash
Use stock index futures to create synthetic positions in equity
 Transaction cost saving
 Liquidity
Long stock + Short futures = Long risk-free bond
Long stock = Long risk-free bond + Long futures

Constructing a synthetic index fund

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2531

Multiplier tells you how many shares you effectively have per contract
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2531

Actual synthetic investment:
Invest this amount at risk free rate:

Number of shares effectively purchased:

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Dividend yield of 2.5% is used in calculations but fund does NOT earn these dividends
Strategy depends on correct pricing of futures contracts
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Equitizing Cash: take a given amount of cash and convert into an
equity position while maintaining liquidity provided by cash

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3.4 Creating Cash out of Equity
Scenario on 2 June:

Construct synthetic position in cash buy selling futures against a long stock
position

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End of Video Segment 1


4. Asset Allocation with Futures
Most important factor in the performance of an asset portfolio is
the allocation of the portfolio among asset classes
We can allocate a portfolio among asset classes using futures
4.1 Adjusting the Allocation among Asset Classes
4.2 Pre-Investing in an Asset Class

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4.1 Adjusting the Asset Allocation among Asset Classes
Scenario on 15 November

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