6.5. THE CFO’S CONCLUSION: PROS AND CONS OF FUTURES CONTRACTS
RELATIVE TO FORWARD CONTRACTS 245
to adjust the confidence intervals.) Third, you could use a clever,non-standard
regressiontechnique that tries to capture the relevant lead/lag affects. Examples
are the instrumental-variables estimators by Scholes and Williams (1977) or Sercu,
Vandebroek and Vinaimont (2008), or the multivariate-based beta by Dimson
(1979), or an error-correction model like Sultan and Kroner (1993).6.4.8 Hedging with Futures Using Contracts on More than One Currency
Currency
Occasionally one uses more than one futures contract to hedge. For instance, aus
hedger exposed tonokmay want to useeurandgbpcontracts to get as close
as possible to the missingnokcontract. In principle, the solution is to regress
nokspot prices oneurand gbpfutures prices, and use the multiple regression
coefficients as hedge ratios. Rules of thumb do not exist here. If one uses actual
regression of past time-series data, one would of course resort to first changes (∆S
and ∆f.) or percentage changes.
This finishes our discussion of how to adjust the size of the hedge position for
maturity and currency mismatches. In the appendix we digress on interest-rate
futures—not strictly an international-finance contract, but one that is close to the
FRA’s discussed in an appendix to Chapter 4 which, you will remember, are very
related to currency forwards and forward-forward swaps. We conclude with a dis-
cussion of how forwards and futures can co-exist. Clearly each must have its own
important strengths, otherwise one of them would have driven out the other.
6.5 The CFO’s conclusion: Pros and Cons of Futures
Contracts Relative to Forward Contracts
Now that we understand the differences between futures and forwards, let us com-
pare the advantages and disadvantages of using futures rather than forwards. The
advantagesof using futures include:
- Because of the institutional arrangements in futures markets, the default risk of
futures contracts is low. As a consequence, relatively unknown players without
an established reputation or without the ability to put up substantial margin can
trade in futures markets. This is especially relevant for speculators who are not
interested in actual delivery at maturity. - Because of standardization, futures markets have low transaction costs; commis-
sions in futures markets tend to be lower than in forward markets, especially for
small lot sizes. Remember that to get wholesale conditions in the forward mar-
ket, one needs to deal in millions ofusd, while in the futures section 100,000 or
thereabouts suffices.