Bachelor's thesis (Turku University of Applied Sciences) Degree Program in Business Management

Hedging techniques that are implemented with the use of futures 
contracts. Generally, such hedging operations describe financial 
mechanism of operations on the stock exchange markets through 
opposite (offset) deals with financial instruments and securities 
contracts.
In principle, futures are better known as contracts that accompany financial 
transactions with certain real financial assets (for instance, agricultural 
products) on pre-arranged future conditions, usually date and price.
While early 1970-s introduced the concept of financial futures, nowadays, a 
great variety of financial instruments could be traced to futures contracts, 
including bonds and currencies (Ball, 2011, p. 147; Casu, Girardone and 
Molyneux, 2006, p. 232).
In order to gain a deeper insight into the way futures contracts operate let us 
examine a concrete example, involving a graphical interpretation of a bond sale 
involved in a financial futures contract.
Let’s assume that a seller (A) and buyer (B) initially entered a futures contract 
with a bond as an underlying asset. While party A is scheduled to sell the bond 
at a certain date in the future, according to the agreement B is obliged to pay 
€ 
600 for the 
it.
However, 
when 
the 
time 
to 
conduct 
trade 
arrives, the 
market 
price of the 
bond 
is 
quoted at € 700. Therefore, party B can buy the bond at the initially agreed price 
Profit/Loss
Futures 
Price
0
50
100
150
200
-50
450
500
550
600
650
700
750
Loss
Profit
Buy
Sell

---

75 
TURKU UNIVERSITY OF APPLIED SCIENCES THESIS | Artem Vorobyev 
and immediately resell it for a € 100 profit. In this case, A suffered a loss. As 
you might have already guessed, same would be true in a reverse (loss) 
situation. 
Hedging operations with futures contracts focus on the implementation of three 
different types of transactions:
purchase / sale of real assets or securities that would take actual 
place in the future according to the conditions of price and delivery 
terms, specified in the contract;
sale / purchase of futures contracts in the secondary market 
(opening of a position on the stock market);
eliminating your position in the futures contract by entering into 
reverse (offset) deal with it (closing your position on the market) 
(Ball, 2011, p. 149-150).
Here is a quick example for the offset position trading:
1. Buying 10 futures contracts (at one price) 
2. Selling (offsetting the futures position) 10 futures contracts (when the 
market price rises) 
As a result, an investor has been able to realize profits from the price 
differences between the initial and offset positions. Naturally, even more 
commercial operations are possible with futures contracts in the face of reverse 
positions (reverse position leaves the investor with a positive or negative result) 
The principle mechanism of hedging with the use of futures contracts is based 
on the following assumptions: if a commercial bank, as a seller of certain 
securities, faces financial losses due to the price changes at the time when the 
payments are to be finalized, it can mitigate its losses by acting as a buyer of 
futures contracts on the same amount of securities and vice versa (Ball, 2011, 
p. 149-150).
In order to provide another fine example of this financial transaction, let us take 
a look at an example used by Laurence Ball: “commercial banks hold large 

---

76 
TURKU UNIVERSITY OF APPLIED SCIENCES THESIS | Artem Vorobyev 
quantities of Treasury bonds. They stand to lose a lot if bond prices fall. A bank 
can reduce this risk by selling Treasury bond futures. If bond prices do fall, the 
bank earns profits from its sale of futures. The profits on futures cancel the 
losses on bonds. If prices rise, the bank loses on futures but gains from its bond 
holdings. Either way, the bank’s total profits are insulated from bond-price 
movements” (Ball, 2011, p. 150).
Therefore, the mechanism of investment risk management within this hedging 
group could be separated into two types of transactions with the use of futures 
contracts 
– hedging the purchase and sale of these contracts.