Level III Core · Swaps, Forwards, and Futures Strategies

Anticipating Cash Flows and Pre-Investing with Derivatives

Updated 9 October 2026 · Fact-checked

Pre-investing uses derivatives to get market exposure before cash arrives, or to lock in prices before an expected outflow. You size a futures position so its exposure equals the cash flow: for equities, N = cash ÷ (futures price × multiplier); for bonds, match basis point value. Close the position when the cash flow occurs.

Understand Anticipating Cash Flows and Pre-Investing with Derivatives

Cash does not arrive when you want it. A pension fund gets a large contribution next month. A client will redeem in three weeks. A manager has just received a mandate but needs time to pick securities. In each case the portfolio has a timing gap between when the decision is made and when cash can be traded. If the market moves in that gap, the portfolio loses.

Derivatives close the gap. Futures and swaps need little or no cash up front, so you can take the exposure now and keep the cash earning the risk-free rate. This is called pre-investing (or equitizing cash when the exposure is equity). A long index futures position plus cash behaves like the index itself. This is a synthetic index fund, because, if fairly priced, the futures price is set so that cash plus a long futures position earns about the index total return, with dividends and the risk-free rate embedded in the futures price.

For an expected inflow, you go long futures now. When the cash arrives, you buy the actual securities and close the futures at the same time. Any gain or loss on the futures offsets the change in price of the securities you buy. For an expected outflow (you must sell assets later), you go short futures now. This locks in today's price level for the assets you will sell.

The key skill is sizing. You want the futures to carry the same risk as the cash flow you are covering. For equities, use the number of contracts based on notional value and beta. For bonds, match the basis point value (BPV), which is the price change for a one basis point change in yield. Swaps do the same job: an equity swap gives you the index return without buying the stocks, and an interest rate swap changes duration.

Pre-investing is not risk free. Residual risks are basis risk (the futures do not move exactly like your target assets), tracking error from beta or duration mismatch, margin and variation margin cash needs, and counterparty risk with OTC swaps. Timing of the cash flow itself may also change.

Key rules to remember

Contracts to equitize cash (equity index futures): N = [(β_target − β_current) ÷ β_futures] × [Value ÷ (Futures price × Multiplier)]; For pure cash, β_current = 0. For pure cash with futures beta about 1, N = target beta × Cash ÷ (Futures price × Multiplier). Round to the nearest whole contract.
Contracts for a bond pre-investment (BPV method): N = (BPV_target − BPV_current) ÷ BPV_futures; For pure cash, BPV_current = 0. A positive N means buy (long) futures.
Basis point value: BPV = Modified duration × Market value × 0.0001; Use the value of the position being covered. For futures, BPV per contract is usually given or is derived from the cheapest-to-deliver bond.
Synthetic index fund: Cash + Long index futures ≈ Index exposure; Cash earns the risk-free rate. The futures price embeds the risk-free rate net of dividends, so the combined return approximates the index return if the futures are fairly priced.
Direction of the hedge: Expected inflow → long futures; Expected outflow of assets to be sold → short futures; Reverse the position when the cash flow occurs, and trade the actual securities.

How to solve Anticipating Cash Flows and Pre-Investing with Derivatives questions

Use the same order every time. It keeps your answer short and shows the examiner each point.

1Identify the cash flow: inflow or outflow, the amount, and the timing. Identify the risk: prices rise before you invest, or fall before you sell.
2Choose the instrument and direction: long futures (or receive-index swap) for an inflow; short futures for an expected sale of assets.
3Set the target exposure: the beta or duration (BPV) you want the cash flow to carry. Pure cash has beta 0 and BPV 0.
4Compute the contracts: equity by notional and beta; bonds by BPV. Use the formula and show the inputs.
5Round to a whole number of contracts and state the direction (buy or sell).
6State the exit: when the cash arrives, buy the securities and close the futures together.
7Name the remaining risks that the question asks about: basis risk, beta or duration mismatch, margin cash needs, counterparty risk, or cash flow timing change.

Quickest way: Notional match shortcut

When to use it: Use when the futures beta is about 1 (equity) or when the futures BPV is given (bonds), and the question asks for a number of contracts. The equity shortcut applies to pure cash only.

Equity (pure cash only): divide the cash by (futures price × multiplier). If the target beta is not 1 and the futures beta is about 1, multiply by the target beta. If the portfolio already holds securities, use the full formula with current beta.
Bonds: compute target BPV = duration × cash × 0.0001, then divide by the futures BPV.
Buy for inflows; sell for outflows.
Write the formula line, then the number on its own, so the calculation earns full credit.

Common mistakes in Anticipating Cash Flows and Pre-Investing with Derivatives

Going short futures to cover an expected cash inflow.
Students memorize 'hedge = short' without checking which risk exists.
Fix: Ask what hurts you. With an inflow, you are hurt if prices rise before you buy, so you go long.
Forgetting the multiplier when computing contracts.
The index level looks like the contract value.
Fix: Always compute notional per contract = futures price × multiplier, then divide the cash by it.
Using current portfolio beta or duration as zero by default when a portfolio already holds securities.
Students memorize the cash version of the formula.
Fix: Use β_current or BPV_current from the question. Only use zero for pure cash.
Not reversing the futures when the cash arrives.
Students treat the futures as a permanent holding.
Fix: State that you buy the securities and close the futures at the same time. Otherwise exposure is doubled.
Saying the strategy is risk free or ignoring basis risk and margin.
Pre-investing sounds like it locks in the exact return.
Fix: Name basis risk, beta or duration mismatch, margin and variation margin funding, and counterparty risk for swaps.
Writing a long explanation when the command word asks only for a calculation or to 'identify'.
Students want to show everything they know.
Fix: Match the command word. Calculate means show the number. Justify means one reason tied to the client's objective or constraint.

Worked examples

Example 1

A fund has received a client contribution of $50,000,000 that is currently held in cash. The manager wants full equity market exposure now while stocks are selected. The equity index futures price is 4,000, the multiplier is 250 and the futures beta is 1.0. Calculate the number of contracts to equitize the cash and state the direction.

Show the solution

Target beta = 1.0. Current beta of cash = 0. Futures beta = 1.0.
Notional per contract = 4,000 × 250 = $1,000,000.
N = [(1.0 − 0) ÷ 1.0] × [50,000,000 ÷ 1,000,000].
N = 1 × 50 = 50.
Cash is invested in equity exposure, so the manager buys (goes long) the contracts.
Exit: as stocks are bought, sell the futures in step with the purchases.

Answer: Buy 50 index futures contracts.

Example 2

A bond manager will receive $20,000,000 in three months and will invest it in bonds with a modified duration of 6.0. To protect against a fall in yields (rise in bond prices) before then, the manager uses bond futures with a BPV of $85 per contract. Calculate the number of contracts, state the direction, and say what the manager does when the cash arrives.

Show the solution

Target BPV = 6.0 × 20,000,000 × 0.0001 = $12,000.
Current BPV of the exposure now = 0, because the manager holds no bonds against this cash.
N = (12,000 − 0) ÷ 85 = 141.18.
Round to the nearest whole number: 141 contracts.
Direction: the manager is hurt if yields fall (prices rise) before buying, so go long (buy) futures.
When the cash arrives, buy the bonds and close the futures position. Futures gains or losses offset the change in the bonds' purchase price.

Answer: Buy 141 bond futures contracts now; close them when the cash arrives and the bonds are purchased.

Exam tips

Read the first line for direction: money coming in means long, assets to be sold means short.
Always state the beta or BPV you are targeting before computing contracts; the vignette often gives current exposure that is not zero.
In an essay set, show the formula and the inputs, then the number. A correct number alone also earns full credit, but inputs protect partial credit if the question is multi-part.
When asked to justify choosing futures or a swap, tie it to the client: low transaction cost, speed, no need to sell assets, or liquidity. Mention one drawback such as margin needs or counterparty risk.
If asked for the result at the end of the period, remember that gains or losses on the futures offset the price change in the securities bought, so the effective cost is close to the original price.

Anticipating Cash Flows and Pre-Investing with Derivatives in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Anticipating Cash Flows and Pre-Investing with Derivatives: frequently asked questions

What does it mean to equitize cash with futures?

You hold cash and buy equity index futures with notional value equal to the cash. The cash earns the risk-free rate, the futures give the index return over that rate, so the combined position behaves like an equity investment. It is also called a synthetic index fund.

When do I buy futures and when do I sell them for anticipated cash flows?

Buy futures when you expect to receive cash and want exposure before it arrives, because you are hurt by rising prices. Sell futures when you expect to sell assets later and want to lock in a price level, because you are hurt by falling prices.

How do I size a bond futures position for expected cash?

Compute the BPV of the exposure you want: modified duration × amount × 0.0001. Divide by the BPV of one futures contract. If the portfolio already has bond exposure, subtract its current BPV first.

Can swaps be used instead of futures for pre-investing?

Yes. An equity swap in which you receive the index return and pay a floating rate gives similar exposure, and an interest rate swap can adjust duration. Swaps are customized and avoid daily margin, but they add counterparty risk.