Practical Portfolio Performance Measurement and Attribution, Second Edition

10

Performance Measurement for Derivatives

If all the rich people in the world divided up their money among themselves there wouldn’t be enough to go around.

Christina Stead (1902-1983) House of All Nations (1938) “Credo”

 

Definition A derivative instrument is an asset whose value is derived from the value of another underlying or reference asset.

Typical derivative instruments include futures, forwards, swaps and options plus multiple variations and combinations. They are either traded on organised exchanges or agreed directly in the over-the-counter (OTC) market.

For some, derivatives have a scary reputation following the collapse of Barings Bank in 1995, the bail out of Long-Term Capital Management in 1998 and currency losses by Allied Irish Bank in 2002 to name but three.

Of course, derivatives can be used to generate extreme leverage and hence the possibility of large losses but they also provide the ability to effectively hedge and transfer risk.

FUTURES

A futures contract is an agreement transacted through an organised exchange to deliver an asset at a fixed price in the future.

Equity index future

An equity index futures contract is an agreement to exchange cash compensation payments based on the movements in the level of an equity index. Physical assets are not delivered.

Equity index futures are the most basic form of derivative. They have no market value in a portfolio; instead they have two legs of economic exposure each of equal value, one leg representing the ...