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24 Cards in this Set

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What are the 7 distinct investment strategies that investors use stock index futures for?
1. speculating on the movement of the stock market
2. controlling the risk of a stock portfolio
3. hedging against adverse stock price movements
4. contructing indexed portfolios
5. index arbitrage
6. creating portfolio insurance
7. asset allocation
What is speculating on the movement of the stock market?
don't have to buy many individual stocks, makes aggregate speculation easier
What is controlling the risk of a stock portfolio?
buying stock index future's will increase a portfolio's beta (sensitivity of portfolio to market), selling futures will reduce it; can target a beta at a lower transaction cost
What is hedging against adverse stock price movements?
in hedge, objective is to alter stock portfolio position so that beta is zero; a zero beta is the risk free rate of interest
What is constructing indexed portfolios?
some managers will purchase a group of stocks that "tracks the targeted index" but there is tracking error risk because stocks may not mimic the index; instead manager can use stock index futures
What is index arbitrage?
arbitrageurs monitor the cash and futures markets to see when there are differences between the theoretical futures price and the actual futures price
What is creating portfolio insurance?
put options on stocks indexes can protect the value of a diversified portfolio of stocks
What is the asset allocation decision?
the decision on how to divide funds across the major asset classes
What is asset allocation?
when a manager wants to change his allocation of stocks and bonds; he can sell a futures contract instead of each stock individual which will result in a higher transaction cost
What are the 5 ways that investors use interest rate futures?
1. speculating on the movement of interest rates
2. controlling the interest rate risk of a portfolio
3. hedging against adverse interest rate movements
4. enhancing returns when futures are mispriced
5. asset allocation
What is speculating on the movement of interest rates?
price of a futures contract moves in the opposite direction from interest rates; an investor who wants to speculate that interest rates will rise can sell interest rate futures
What is controlling the interest rate risk of a portfolio?
interest rate futures can be used to alter the interest rate sensitivity of a portfolio
What is hedging against adverse interest rate movements?
interest rate futures can be used to hedge against adverse interest rate movements by locking in either a price or an interest rate
What is enhancing returns when futures are mispriced?
if interest rate futures are mispriced, institutional investors can enhance returns
What is asset allocation?
interest rate futures and stock index futures are quick, cheap and effective ways to change the composition of a portfolio between bonds and stock
What is protective put buying strategy?
an investor can protect himself against a decline in the price of a stock in her portfolio by buying a put option on that stock; put guarantees a minimum price equal to the strike price minus the cost of buying the option
What is the main function of futures markets?
to transfer price risk from hedgers to speculators; risk transferred from those willing to pay to avoid the risk to those wanting to assume the risk in the hope of gain
What is a perfect or textbook hedge?
when the profit and loss on positions are equal
What is basis?
basis = cash price - futures price
What is basis risk?
the risk that the hedger takes on is that the basis will change; hedger substitutes basis risk for price risk
What is cross hedging?
when a futures contract is used to hedge a position where either the portfolio or the individual financial instrument is not identical to the instrument underlying the futures
What is cross-hedging risk?
risk that the price movement of the underlying instrument of the futures contact does no accurately track the price movement of the portfolio or financial instrument hedged
What is a short hedge or a sell hedge?
used to protect against a decline in the cash price of a financial instrument; hedger sells a futures contract
What is a long hedge or a buy hedge?
undertaken to protect against an increase in the price of a financial instrument to be purchased in the cash market at some future time; hedger buys a future contract