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Glory glory Man United!
Sunil Bhandari explains how you can best tackle questions on financial futures
Financial futures feature in both the ACCA F9 and P4 papers, but tested in different ways and depth. The common ground is the use of futures as an instrument to hedge foreign currency and/or interest rate risk. From my experience, students find this topic challenging. The aim here is to provide an ‘off-the-cuff explanation’ of the concept behind using futures as a risk management tool.
As all the students I have taught know, I am a supporter and season ticket holder of Manchester United (respect to those who follow other teams). My wife thinks, on occasions, I love Man Utd more than her – no comment!
I always want my team to win (the upside gain) and I am obviously unhappy on that rare occasions when they lose (downside risk). So imagine this. I am about to go to Old Trafford to watch my team play in a cup game, which has to be decided on that day. Hence, only two results are possible – we win or we lose.
If Man Utd lose I will not feel good. I could compensate and cover this to a certain extent by taking a bet that my team will lose the game. I am in effect, betting that the downside will occur. I am assuming that winning some money will match or at least improve my mood if Man Utd fails to win the game.
So now the game is played and after the game I have no voice – which is the norm for me. Let’s say Man Utd win. I feel ecstatically happy. However, I lost on my bet and hence my mood is tempered down due to my financial loss. But if Man Utd lose then I go into a sulk (which is true!). However, my mood is improved when my winnings come into my bank as I gained on my bet. Overall, whether Manchester Utd wins or loses I am approximately in the same position either way.
This is the concept of how futures are used in risk management. It is accepted we have use the correct terms like ‘buy’ or ‘sell’ rather than bet and that there are complications such as margins and basis risk. However, the basic idea is correct.
For the record, I have NEVER EVER bet that my team Man Utd will lose!
• Sunil Bhandari is a freelance ACCA F9 and P4 tutor
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