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Portfolio management - futures for immunisation

Discussion in 'SP5' started by Benjamin, Apr 15, 2018.

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  1. Benjamin

    Benjamin Member

    Hi,

    Reference: CMP Ch22, p.18

    With regards to the sentence: "Being dealt on margin, futures are very volatile. This means that bond futures can be used to match long-term liabilities"?

    Could you please explain:
    1. What is meant by "dealt on margin"?
    2. Why being dealt on margin makes futures volatile?
    3. Why this is a particular match for long-term liabilities - as surely plenty of long-term liabilities are not volatile in nature (e.g. a regular annuity is extremely predictable)?
     
    Benjamin, Apr 15, 2018
    #1
  2. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    Dealt on the margin means that you can gain a lot of exposure to bond markets, but you dont have to pay for it with cash - only fund a small margin account. So you can really get a lot of bang for your buck!
    If you get a high exposure using just a small margin deposit, your profits and losses, relative to your cash deposit, are VERY great indeed. So very 'volatile'.
    Long term liabilities are quite volatile actually. If you have an annuity to fund, the cost of doing that today if long term interest rates are 1%, is very different from the cost of doing it today when interest rates are 5%. It is good to hedge this by buying long term bonds, which are equally volatile when rates change. But if you dont want to commit that much cash to hedge the annuity cost, you can get a lot of bond exposure using futures, while just using a small fraction of your available cash.
     
    Colin McKee, Apr 20, 2018
    #2

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