Chapter 13

Question 15: Why would a pension fund or insurance company consider selling stock index futures?

The most common pension plan is a defined benefit plan. Employees receive a payment equal to a percentage of the average salary that they received over the last few years of employment with their employer. The formula, which includes years with the same company, sets the payment amount. A combination of employee and employer contributions fund benefits, with employers paying the largest share.

Index futures are futures contracts on a stock or financial index. For each index, there may be a different multiple for determining the price of the futures contract.

If a pension fund or insurance company anticipates a temporary decline in stock prices, it may attempt to hedge its stock portfolio by selling stock index futures.

Chapter 14

Question 10: Describe a put option on interest rate futures. How does it differ from selling a futures contract?

A put option is a contract that gives the owner a right, but not the obligation, to sell a stock at a predetermined price within a certain period. The seller of the futures contract (the party with a short position) agrees to sell the underlying commodity to the buyer at expiration at the fixed sales price. As time passes, the contract’s price changes relative to the fixed price at which the trade was initiated. This creates profits or losses for the trader.

A put option on interest rate futures provides the right to sell a specified interest rate futures contract that contains a specified price, and an owner of a put option on an interest rate futures contract allows one the right to sell the underlying instrument on the settlement date specified by the futures contract, if the put option on futures is exercised. but there is no obligation unless the put option on futures is exercised.