Investments, tenth edition

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3

 P

AR

T VI 

  THE PREVIOUS CHAPTER 

provided a basic 

introduction to the operation of futures mar-

kets and the principles of futures pricing. This 

chapter explores both pricing and risk man-

agement in selected futures markets in more 

depth. Most of the growth has been in finan-

cial futures, which dominate trading, so we 

emphasize these contracts. 

    Hedging    refers to techniques that offset 

 particular  sources of risk. Hedging activities 

therefore are more limited and more focused 

than more ambitious strategies seeking an 

optimal risk-return profile for an entire port-

folio. Because futures contracts are written 

on specific quantities such as stock index 

values, foreign exchange rates, commodity 

prices, and so on, they are ideally suited for 

these applications. In this chapter we will con-

sider several hedging applications, illustrating 

general principles using a variety of contracts. 

We also show how hedging strategies can 

be used to isolate bets on perceived profit 

opportunities. 

 We begin with foreign exchange futures, 

where we show how forward exchange rates 

are determined by interest rate differentials 

across countries and examine how firms can 

use futures to manage exchange rate risk. We 

then move on to stock-index futures, where 

we focus on program trading and index 

arbitrage. Next we turn to the most actively 

traded markets, those for interest rate 

futures. We also examine commodity futures 

pricing. Finally, we turn to swaps markets in 

foreign exchange and fixed-income securities. 

We will see that swaps can be interpreted as 

portfolios of forward contracts and valued 

accordingly.