CFA 2018 r28 risk management applications of forward and futures strategies

Level III Risk Management Applications of Forward and Future Strategies www.ift.world Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents 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 www.ift.world Introduction • Forwards • Futures • Arbitrage • Hedging • Managing Risk www.ift.world 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 www.ift.world 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 www.ift.world 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 www.ift.world 3.2 Managing the Risk of an Equity Portfolio September Why is N positive? What is the risk? www.ift.world Scenario on December Is the same as the target beta? www.ift.world www.ift.world www.ift.world 10 4.2 Pre-Investing in an Asset Class Pre-investing: Use futures contracts to gain exposure to an asset class without a cash outlay; when cash is received close out the futures position and invest the cash www.ift.world 30 www.ift.world 31 www.ift.world 32 www.ift.world 33 Strategies and Applications for Managing Foreign Currency Risk • Transaction exposure • Translation exposure • Economic exposure 5.1 Managing the Risk of Foreign Currency Receipt 5.2 Managing the Risk of a Foreign Currency Payment 5.3 Managing the Risk of a Foreign Market Asset Portfolio www.ift.world 34 5.1 Managing the Risk of Foreign Currency Receipt www.ift.world 35 www.ift.world 36 5.2 Managing the Risk of a Foreign Currency Payment www.ift.world Do Example 37 5.3 Managing the Risk of a Foreign-Market Asset Portfolio www.ift.world 38 Does such a strategy make sense in the short run? Long run? www.ift.world 39 From the previous example we see that the possible currency hedging strategies are: Hedge market risk and not currency risk  foreign risk free rate Hedge both  domestic risk free rate Hedge currency risk but not market risk Hedge neither Effectiveness of hedge depends on: how well hedging instrument is correlated with investment portfolio how well the final investment value is predicted www.ift.world 40 Forwards and Futures www.ift.world 41 www.ift.world 42 www.ift.world 43 Conclusion • Read Section (Final Comments); very useful 1.5 pages • Summary • Examples • Practice Problems • Learning Objectives www.ift.world 44 ... Introduction Strategies and Applications for Managing Interest Rate Risk Strategies and Applications for Managing Equity Market Risk Asset Allocation with Futures Strategies and Applications. .. 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 www.ift.world Strategies and Applications for... 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 www.ift.world 3.1 Measuring and