CHAPTER 20
Use of Stock Index Futures and Treasury Futures Contracts in Portfolio Management
In the previous two chapters, we explained the management of equity and bond portfolios. Our attention was on the implementation of investment strategies by buying or selling individual securities. Without futures, asset managers would have only one trading location to alter portfolio positions when they get new information that is expected to influence the value of assets they manage—the cash market, also called the spot market. If adverse economic news is received, asset managers can reduce their price risk exposure to that asset by selling the asset. The opposite is true if the new information is expected to impact the value of that asset favorably: An asset manager would increase price risk exposure to that asset, buying additional quantities of that asset.
There are, of course, transaction costs associated with altering exposure to an asset—explicit costs (commissions) and hidden or execution costs (bid-ask spreads and market impact costs), which we discussed in Chapter 18. The futures market is an alternative market that asset managers can use to alter their risk exposure to an asset when new information is acquired. But which market—cash or futures—should the money manager employ to alter a position quickly on the receipt of new information? The answer is simple: the one that more efficiently achieves the investment objective of the asset manager. The factors to consider are liquidity, ...

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