Two things must be kept in mind when establishing a long position in this kind of hedge. First, since Treasury bond futures contractsrepresent face value of $100,000 worth of Treasury bonds, the investor will want to go long approximately $100,000 worth of closed-end bondfunds. When it comes to trading closed-end bond funds, I do not recommend buying more than 2000 or 3000 shares of a single fund for a short-term trade. That is why we would go long several different closed-end funds, representing positions of from $31,000 to $34,000 and amounting to approximately $100,000. That $100,000 long position offset the short position of 1 September U.S. Treasury bond futures contract at 100.18, priced at a 7.943 yield.
On February 10, 1978, with the Dow Jones Bond Average down to 89.79, two significant changes had taken place since we established our theoretical long and short positions: (1) The long positions in the bond funds had become profitable, and (2) so had the short position in the Treasury bond futures contract. For example, JHS was selling at 175/8, up from 167A; DBF was up to 165/8 from 161/2; and PAI had gone from 135/8 to 1334. The net asset values of all three funds had declined but the discounts, as predicted, narrowed more than the decline in net asset values, resulting in the profits. Read the rest of this entry »
Currency swap: Contract that commits two counterparties to exchange streams of interest payments in different currencies for an agreed period of time and to exchange principal amounts in different currencies at a pre-agreed exchange rate at maturity.
A currency swap has three stages:
An initial exchange of principal: the two counterparties exchange principal amounts at an agreed exchange rate. This can be a notional exchange since its purpose is to establish the principal amounts as a reference point for the calculation of interest payments and the re-exchange of the principal amounts.
Exchange of interest payments on agreed dates based on outstanding principal amounts and agreed fixed interest rates.
- Re-exchange of the principal amounts at a predetermined exchange rate so the parties end up with their original currencies.
- Again this may be done to hedge risk, to speculate on changes in exchange rates, or to attempt to lower the cost of borrowing by borrowing in the currency in which the most favourable interest rates are available and then swapping into the currency that the firm needs to carry out its business. Whether this will be cheaper will depend among other things on the bid—offer spread.
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An interest-rate agreement is an agreement between two parties whereby one party, for an upfront premium, agrees to compensate the other at specific time periods if a designated interest rate, called the reference rate, is different from a predetermined level. When one party agrees to pay the other when the reference rate exceeds a predetermined level, the agreement is referred to as an interest-rate cap or ceiling. The agreement is referred to as an interest-rate floor when one party agrees to pay the other when the reference rate falls below a predetermined level. The predetermined interest-rate level is called the strike rate.
The terms of an interest-rate agreement include
- The reference rate
- The strike rate that sets the ceiling or floor
- The length of the agreement
- The frequency of settlement
- The notional principal amount
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Client research by Benefits, Inc. shows that plan participants may be usefully grouped into three major segments based on their attitudes toward, and sophistication with, investment concepts. Plan sponsors should consider positioning options to relate to the needs of each segment.
Insecure investors usually compose the largest single participant group. These individuals describe themselves as “beginner” investors. They express a lack of confidence and understanding in matters related to investing and doubt their ability to accumulate enough assets to retire. Their lack of confidence has pushed them into relatively safe investment choices such as money market, fixed income and stable value options. They tend to be the least well diversified. Some avoid participating in a 401(k) plan altogether because of their lack of confidence. Read the rest of this entry »
Driven by a combination of management-initiated efforts to improve defined contribution plans and increasing employee bottom-up requests for a wider array and range of investment options, the average number of choices offered by Benefits, Inc. clients is now 10, compared to 3 or 4 choices 10 years ago. Indeed, many large companies offer 75 or more options. However, a concern is whether these additional options are being used properly. Read the rest of this entry »
What if a stock has run out of steam and we’re anticipating a period of consolidation or lower volatility for a period of time? What if we have identified a range-bound stock and we want to take advantage of this price pattern behavior? We can achieve this by trading low-risk, high-reward options strategies! The two strategies we’ll discuss in this chapter are the Butterfly and the Condor, both of which produce profits provided the price remains within a certain price range, determined by the Exercise prices we select.
Butterflies
The Butterfly involves the following steps (you can use all calls or all puts with the Butterfly—you cannot mix the two):
Butterfly with Calls
Step 1 Buy 1 lower strike (ITM) call
Step 2 Sell 2 middle strike ATM calls
Step 3 Buy 1 higher strike (OTM) call
There are two key points here:
- The ratio between buying the ITM call, selling the ATM calls, and buying the OTM call is 1:2:1.
- The distance between the three adjacent strikes must be equal, with the middle strike being ATM or as close to ATM as possible.
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It’s likely that most investors, at some point in their investing careers, buy and sell much too quickly. Perhaps they get caught up in a market upturn or downswing or they are going through a difficult period in their personal lives and turn to day trading as a form of escape. If overactive trading is an anomaly rather than a pattern, then you probably aren’t guilty of this sin. On the other hand, if you find that you periodically fall into the habit of overactive investing, gluttony may be a problem you need to address. Read the rest of this entry »
