7
Using derivatives
in investment
management
Introduction
There are numerous ways in which derivative products are used in
investment decisions. The fund mandate, regulatory requirements,
investment objectives and relevance to the market conditions deter-
mine strategies and product selection.
Other key issues include liquidity and market risk, counterparty
risk, and the operational risk environment.
In this chapter we shall look at some basic examples of different ways
of using derivatives in the fund and investment management process.
Basic illustration of derivatives use in asset allocation
A fund manager has a portfolio made up of equity shares in the
United States and United Kingdom, Gilt stocks and cash. The current
ratio is 40 per cent of the fund invested in US equities, 20 per cent in
UK equities, 20 per cent in Gilt stock, 10 per cent in Japanese stock
and 10 per cent cash.
The fund manager believes that the US equity market is due a fall
and that Japan will rise. They expect this to occur in the next six to
eight weeks.
The fund manager can adjust the balance of the portfolio by selling
US shares and purchasing stocks in Japanese-based companies.
They will need to research the markets then undertake several trans-
actions and therefore it may take some time to achieve. Commission
fees will be incurred for each transaction.
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