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24 Cards in this Set
- Front
- Back
What are the 7 distinct investment strategies that investors use stock index futures for?
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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 |
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What is speculating on the movement of the stock market?
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don't have to buy many individual stocks, makes aggregate speculation easier
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What is controlling the risk of a stock portfolio?
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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
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What is hedging against adverse stock price movements?
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in hedge, objective is to alter stock portfolio position so that beta is zero; a zero beta is the risk free rate of interest
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What is constructing indexed portfolios?
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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
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What is index arbitrage?
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arbitrageurs monitor the cash and futures markets to see when there are differences between the theoretical futures price and the actual futures price
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What is creating portfolio insurance?
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put options on stocks indexes can protect the value of a diversified portfolio of stocks
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What is the asset allocation decision?
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the decision on how to divide funds across the major asset classes
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What is asset allocation?
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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
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What are the 5 ways that investors use interest rate futures?
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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 |
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What is speculating on the movement of interest rates?
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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
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What is controlling the interest rate risk of a portfolio?
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interest rate futures can be used to alter the interest rate sensitivity of a portfolio
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What is hedging against adverse interest rate movements?
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interest rate futures can be used to hedge against adverse interest rate movements by locking in either a price or an interest rate
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What is enhancing returns when futures are mispriced?
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if interest rate futures are mispriced, institutional investors can enhance returns
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What is asset allocation?
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interest rate futures and stock index futures are quick, cheap and effective ways to change the composition of a portfolio between bonds and stock
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What is protective put buying strategy?
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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
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What is the main function of futures markets?
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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
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What is a perfect or textbook hedge?
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when the profit and loss on positions are equal
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What is basis?
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basis = cash price - futures price
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What is basis risk?
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the risk that the hedger takes on is that the basis will change; hedger substitutes basis risk for price risk
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What is cross hedging?
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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
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What is cross-hedging risk?
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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
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What is a short hedge or a sell hedge?
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used to protect against a decline in the cash price of a financial instrument; hedger sells a futures contract
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What is a long hedge or a buy hedge?
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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
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