Derivative Market

Derivatives for Asset Management Company



Derivatives for Asset Management Company

Introduction

Central bank of every country has been a subject of attention all over the world. The decisions of state bank affect the economic situation of the citizens of the country and the firms operating within the country. According to the given situation, there is a high probability of change in policies by Central Bank regarding asset prices. Every firm wants to be at a position of minimum risk-highest return. As every company sets the range of maximum risk and minimum return, an optimum portfolio is generated. Every stock and bond has different level of risk association. Hence, it becomes necessary for an asset management firm to create a portfolio that is hedged against all risks. This will help them to create a portfolio according to the policies of the company.

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Discussion

Central Bank has the responsibility to keep the price stability and stable inflation rate. For this purpose, it changes the monetary and fiscal policies time to time. It becomes evident from the economic situation of the country, if there is a need of contraction or expansion of currency. Central bank accomplishes this task by changing the interest rates on government bonds. These regulations can sometimes result in bubble and eventually a prick of that bubble (Winter, 2009).

Every company chooses a position of risk and return according to the stakeholders' needs. The company that is risk averse would always go for a less risk investment. In contrast, the risk taker company would go for high risk assets because it will give higher returns for the company. The investors always try to offset their risks through different means. It is not possible for any individual or company to offset all the risk associated with the investment, however, the derivative market helps them to reduce the risk as much as possible. The companies make portfolios to diversify the risks and gain maximum profits. According to the financial terminology, the company is at the position of long if it buys a particular item in future. Similarly, the company that sells the underlying item is known as short.

Question 1 - Bond Futures and Index Futures

Future contracts are the most common type of derivatives used for hedging the risks. The future contract helps the company to reduce the risk and avoid the price variations. Bond futures help in hedging the risk of future shifts of interest rates. In this case, the party makes a contract to buy or sell a commodity or financial asset at some known future time at a known price and specific conditions (Evans, 2012). According to the predictions of the Asset manager, the yields on bond will rise. So, the worth of those bonds will rise. Currently the BTP Bund of 10 years is of 140.40 Euros. The coupon on these ten years government bonds is 6% which is the risk free rate. The Euro Bund future price after three months is ...