USE OF FUTURES MARKET RY INDEX FUNDS
Futures markets can be used for creating synthetic index funds. Synthetic index funds created using futures contracts have advantages of simplicity and low costs. The simplicity stems from the fact that index futures automatically track the index. The cost advantages stem from the fact that the costs of establishing and rebalancing the fund are substantially reduced because commissions and bid-ask spreads are lower in the futures markets than in the equity markets.
The Methodology for creating a synthetic index fund is to combine index futures contracts with bank deposits or treasury bills. The index fund uses part of its money as margin on the futures market and the rest is invested at the risk-free rate of return. This Methodology however does require frequent roll-over as futures contracts expire.
Index funds can also use the futures market for the purpose of spreading index sales or purchases over a period of time. Take the case of an index fund which has raised Rs.100 crore from the Market. To reduce the tracking error, this money must be invested in the index immediately. However large trades face large impact costs. What the fund can do is, the moment it receives the subscriptions it can buy index futures. Then gradually over a period of say a month, it an keep acquiring the underlying index stocks. As it is acquires the index stocks, it should unwind its position on the futures market by selling futures to the extent of stock acquired. This should continue till the fund is fully invested in the index.
QUESTIONS & ANSWERS ON CHAPTER TWO
Q. Assume that the base value of a Market capitalization weighted index were 1000 and the base market capitalization were Rs.35000 crore. If the current market capitalization is Rs. 77.000 crore. the index is at 1. 2010
- 2050
- 2500 .
- None of the above.
A. The current Index value is (77000/35000* 1000) = 2200 The correct answer is No. 1 .
Q. Nifty includes the………. most liquid stocks that trade on NSE.
1.30
2.50 .
3.100
4.500
A. The correct Answer is NO.2
Q- The market impact cost on a trade of Rs.3 Million of the full Nifty works out to be aboutO.5%. This means that Nifty is at 2000. a buy order will go through at roughly
- 2010
- 2050
- 2500
- None of the above.
A. 0.5% of 2000 works out to be 5. Hence a buy order will go through at 2010. So the correct Answer is NO. 1
Q. The Indian company which provides professional index management services is
- IISL
- NSCCL
- S&P
- CRISIL
A. The correct Answer is No. 1
Q. Impact costs measures the
- Volatility of the stock
- Liquidity of the stock
- Return on a stock
- None of the above
A. The correct Answer is NO.2
Q. Index Funds are………………… Managed.
- Actively .
- Passively
- Family
- None of the above
A. The correct Answer is NO.2
