How can futures be used to man
How can futures be used to manage interest rate risk in a fixedincome portfolio? How can futures be used to manage beta in anequity portfolio? Explain the mechanics of a fixed-floating swap,describing the rationale for each participant.
Answer:
1]
If interest rates rise, bond prices fall. Therfore, if interestrates rise, the value of a fixed income portfolio would fall.
Bond futures have bonds as the underlying. Thus, if interestrates rise, bond futures would fall in value.
Therefore, to hedge a fixed income portfolio against interestrate risk, bond futures can be sold. The fall in value of the fixedincome portfolio would be offset by the gains on the bond futures,thus hedging interest rate risk
2]
Futures can be bought or sold to modify the beta of an equityportfolio.
Usually, the portfolio beta is different from the futuresbeta.
To increase portfolio beta, futures contracts should be bought,and to decrease portfolio beta, futures contracts should besold.
The number of futures contracts to buy or sell = ((target beta -portfolio beta) / futures beta) * (portfolio value / (futures price* contract multiplier))
3]
In a fixed-floating swap, the fixed rate payer pays a fixedinterest rate on the notional amount, and the floating rate payerpays a floating rate, based on some reference rate.
A fixed rate payer may enter into a fixed-floating swap toconvert their floating rate obligation into a fixed rateobligation. This could be the case if they believe that interestrates may rise in the future.
A floating rate payer may enter into a fixed-floating swap toconvert their fixed rate obligation into a floating rateobligation. This could be the case if they believe that interestrates may fall in the future.
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