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CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses

A portfolio manager holds a diversified equity portfolio and expects a short-term market decline but does not want to sell the shares because of transaction costs and tax consequences. Which derivative strategy is the manager most likely to use to reduce the portfolio's equity exposure?

The manager would most likely sell equity index futures. The short futures position gains when the market falls, offsetting losses on the portfolio, and lowers equity exposure quickly and cheaply without selling the shares, which avoids transaction costs and taxes.

  1. ABuy equity index futures
  2. BSell equity index futuresCorrect
  3. CBuy a stock index call option

Explanation

Selling index futures creates a short position that offsets losses on the held shares, reducing market exposure without selling the underlying stocks. Buying futures or calls would add exposure to the market rather than reduce it.

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