15.

a. Explain why you agree or disagree with the following statement by Gary Gastineau:

Stock index futures and options were introduced in the early 1980s. Their introduction was partly a response to institutional portfolio managers’ preference for trading portfolios rather than individual stocks and partly a way of reducing transaction costs in the implementation of asset-allocation and market-timing decisions.

b. In the same article, Gary Gastineau made the following statement:

Long positions in stock index futures combined with short-term fixed income securities are an almost perfect substitute for a stock index portfolio. Conversely, selling futures contracts against a portfolio of stocks is a low-cost way to reduce market exposure.9 Explain the conditions that must hold for this statement to be true.

16. An associate who is not an expert in financial futures has been reviewing a publication describing the three-year and 10-year Moscow City bonds published by the Russian Trading System Stock Exchange.

In the publication, the following appears:

Futures on the 3Y and 10Y Moscow City bonds are standard long-term contracts. The underlying asset—the basket of bonds issued by the Government of Moscow—is the benchmark Russian fixedincome market instrument. Futures on the bond basket allow investors to hedge not only risks associated with Moscow City bonds but also risks related to bonds issued by other entities.

The publication goes on to say:

Futures on the 3Y and 10Y Moscow City bonds provide fixed-income traders with the following additional advantages:

• portfolio risk management

• short-selling abilities

• bond margin trading abilities

• the ability to create synthetic “short-term” bonds

• portfolio duration management abilities

• reduction in transaction costs

• using the spreads between the short-term and long-term interest rates without using the underlying assets

• using the spreads between the hard currency-denominated and ruble-denominated interest rates without using the underlying assets

• arbitrage possibilities.

Your associate has asked you to explain the following advantages from using these contracts:

a. Hedging “not only risks associated with Moscow City bonds but also risks related to bonds issued by other entities.”

b. “Short-selling abilities.”

c. “Portfolio duration management abilities”

d. “Reduction in transaction costs.”

e. “Using the spreads between the short-term and long-term interest rates without using the underlying assets.”