Derivatives (6/50)

This is a technique employed by portfolio managers to reduce portfolio risk, such as

the impact of adverse price movements on a portfolio’s value.

• Hedging

• Anticipating future cash flows

• Asset allocation changes

• Arbitrage

Closely linked to the idea of hedging, if a portfolio manager

expects to receive a large inflow of cash to be invested in a particular asset, then futures can be used to fix the price at which it will be bought and offset the risk that prices will have risen by the time the cash flow is received.

• Hedging

• Anticipating future cash flows

• Asset allocation changes

• Arbitrage

Changes to the asset allocation of a fund, whether to take advantage

of anticipated short-term directional market movements or to implement a change in strategy, can

be made more swiftly and less expensively using derivatives such as futures than by actually buying

and selling securities within the underlying portfolio.

• Hedging

• Anticipating future cash flows

• Asset allocation changes

• Arbitrage

The process of deriving a risk-free profit from simultaneously buying and selling the

same asset in two different markets, when a price difference between the two exists. If the price of

a derivative and its underlying asset are mismatched, then the portfolio manager may be able to

profit from this pricing anomaly.

• Hedging

• Anticipating future cash flows

• Asset allocation changes

• Arbitrage

Involves assuming additional risk (betting) in an effort to make, or increase, profits in

the portfolio

• Hedging

• Anticipating future cash flows

• Arbitrage

• Speculation

a legally binding agreement between a buyer and a seller. The buyer agrees to pay a

pre-specified amount for the delivery of a particular pre-specified quantity of an asset at a pre-specified future date. The seller agrees to deliver the asset at the future date, in exchange for the pre-specified amount of money.

• Future

• Option

gives a buyer the right, but not the obligation, to buy or sell a specified quantity of an

underlying asset at a pre-agreed exercise price, on or before a pre-specified future date or between two specified dates.

• Future

• Option

the term used for the position taken by the buyer of the future

• Long

• Short

• Open

• Close

the position taken by the seller of the future

• Long

• Short

• Open

• Close

the initial trade

• Long

• Short

• Open

• Close