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Adjusting a Portfolio between Equity and Debt using Futures



This post expands on our coverage of using futures contracts to modify portfolio duration and using futures to modify portfolio beta. Here we tie both of these together in a single calculation question asking you to adjust a portfolio between debt and equity exposure by both buying/selling contracts on bond and stock futures. 

This type of calculation question is virtually guaranteed to be tested on the CFA Level 3 exam. 

Adjusting a portfolio between equity and debt

Adjusting a portfolio between debt and equity is basically exactly the same set of processes we walk through in those previous posts in terms of adjusting a portfolio’s duration or beta.

That is, the process of adjusting between bonds and equities still involves buying and selling futures contracts in order to adjust exposure, whether beta or duration, accordingly.

Reallocating exposure from bonds to equities

  1. Remove all duration (MD = 0) by shorting bond futures
  2. Add systemic risk to the position (Beta > 0) by buying stock index futures

Reallocating exposure from equities to bonds

  1. Remove all systematic risk (Beta = 0) by shorting the right amount of stock index futures
  2. Go long/buy bond futures (MD > 0) to add the correct level of duration exposure

Let’s clarify by walking through an example of moving from equities to bonds.

An example of adjusting portfolio exposure using futures

First, take our target beta exposure (which could be 0 or some other value) and plug taht value into our equation for modifying target beta. This will determine the appropriate number of futures contracts to buy OR sell. 

adjusting portfolio beta for CFA Level 3

Next, adjust our bond portfolio duration by buying or selling the appropriate number of bond futures:

adjusting portfolio duration CFA Level 3

Note the difference between the equations. In the second one we are using modified duration instead of beta, and we also add a yield beta to the equation. The yield beta will either be given or you can assume it is equal to one. This equation should look very familiar to the cheapest-to-deliver bond equation from earlier in the CFA Level 3 curriculum. 

Adjusting portfolio exposure to sectors

The same basic approach we just outlined can also be used to adjust an equity portfolio across different sectors. To do this:

  • Set the target beta exposure for a particular sector
  • Determine if you are increasing (buying) or decreasing (selling) futures contracts for that sector
  • Calculate the # of futures contracts you need to buy or sell to adjust its beta
  • Repeat the process for any other sector

Effectively, you turn whichever position you are reducing exposure to into cash, and then use that cash to increase exposure to another sector.

The keys to remember for adjusting bond and equity exposure 

There are four key lessons:

Adjusting Duration

  • To INCREASE the duration of a bond portfolio BUY bond futures
  • To DECREASE the duration of a bond portfolio SELL bond futures

Adjusting Portfolio Beta

  • To INCREASE a portfolio’s beta BUY futures contracts
  • To DECREASE a portfolio’s beta SELL futures contracts