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USE OF FUTURES Ch. 5 b

USE OF FUTURES Ch. 5 b. Use of Futures. Besides Hedging : Speculating: Futures and Futures Markets can also be used for. Use of Futures (Con.). Asset Allocation : Switching from one asset type to another : from Stocks to T-Bills Keep long position in stock, short sell Index Futures

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USE OF FUTURES Ch. 5 b

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  1. USE OF FUTURESCh. 5 b

  2. Use of Futures Besides • Hedging: • Speculating: Futures and Futures Markets can also be used for Dr. C. Ertuna

  3. Use of Futures (Con.) • Asset Allocation: • Switching from one asset type to another: from Stocks to T-Bills Keep long position in stock, short sell Index Futures • Fine tuning asset allocation: From T-Bills to T-Bonds Keep long position in stock, short sell Index Futuresand go long on T-Bond Futures. Dr. C. Ertuna

  4. Use of Futures (Con.) • Adjusting Beta of a Portfolio: Cross Hedging with Index Futures • Price Discovery: Establishing prices several years before the harvest • Hedging Underlying Assets that do not have Futures Market: Cross-Hedging with Commodity Futures Dr. C. Ertuna

  5. Adjusting Beta of a Portfolio Consider a portfolio (portfolio-p) with a beta of 1.4 Under a very strong assumption that the beat of portfolio-p won’t change (in other words perfect correlation between Index and portfolio-p) We can adjust the beta of portfolio-p with Index Futures. If the assumption does not hold there will be a residual risk that cannot completely be covered. Dr. C. Ertuna

  6. Adjusting Beta of a Portfolio The beta of portfolio-p can be adjusted by using following formula: where, = Number of Contracts to Adjust Beta (or Hedge) If negative take a short position, if positive take a long position = Target Beta (desired beta) = Actual Beta of Portfolio-p = Investment Amount of the Portfolio-p = Notional value of 1-Index_Contract (= Contract Size of 1-Index_Contract * Index Value) Dr. C. Ertuna

  7. Hedged Portfolio The Hedged Portfolio consists of two portfolios Portfolio-p and Index Futures. Position in the Index Futures could be long or short depending to targeted adjustment. The Payoff of the Hedged Portfolio is The Variance of the Hedged Portfolio is Taking the derivative of the equation with respect to H and substituting with will result in Variance minimizing hedge position Dr. C. Ertuna

  8. Variance of Hedged Portfolio When we rewrite Using H* it will yield Since for a simple regression of the regression on can be used for Dr. C. Ertuna

  9. TABLE 5.10 (p 148) • Application of “Adjusting Beta of a Portfolio” Excel File: Using Index Futures to Adjust a Portfolios Beta - Work Dr. C. Ertuna

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