Interpret the following statements made by Wall Street analysts and portfolio managers. a. “The existence of...

Interpret the following statements made by Wall Street analysts and portfolio managers.

a. “The existence of financial futures contracts allows our firm to hedge against temporary market declines without liquidating our portfolios.”

b. “Given my confidence in the market, I plan to use stock index futures to increase my exposure to market movements.”

c. “We used currency futures to hedge the exchange rate exposure of our international mutual fund focused on German stocks.”

Expert Solution

Answer(a): Futures- is the derivative contract that is arrangement between two parties (buyer and seller) to buy or sell certain asset at a specified price and time in future.

Futures are used in Hedging- Hedging is a techniques to minimize risk. Future contracts are used for hedging purpose, they hedge against the unexpected price movements in future. When a company is going to buy some items in the future and it expects that the price can go up then it can fix a price that it will pay in the future, by buying future contract. On the other hand, if company is selling something in the future, it expects that price will drop, it can take a short position in futures contract.

Furfures are based on underlying, that underlying asset can be equity, commodity or currency.

Answer(b): Stock index futures- These are available in stock market for trading, that track key market indices. It is a legal agreement between two parties to buy or sell stocks on a future date at a specified price. These are used for speculation purpose. With the help of stock index futures, investors can make money, this can be traded with low capital also. When trader things that price will go up or index will rise, he buys the stock index futures and vice versa.

Answer(c): Currency futures- Are used to hedge the exchange rate risk, exchange rate risk is the forex risk that arises due to fluctuation in currencies of two or more countries. Currency futures are used to hedge the risk of getting payment or paying in foreign currency. Currency future contract is an agreement to exchange the price in one currency to another in a future date.

In international trading and mutual funds, currency futures are widely used. Underlying asset of currency futures is Spot rate of currency pair. Currency futures are used for hedging and speculation purpose.

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