E risk and returns has attracted much attention from academics and practitioners. Three benefits of using futures are usually identified: Speculation, through which portfolio managers hope to profit by buying or selling contracts; arbitrage, through which managers take advantage of price inconsistencies by simultaneous purchase and sale of equivalent assets in different markets; and hedging, through which managers expect to eliminate all risk in a position by an offsetting transaction in the futures market. While the riskless hedge is useful for explaining the functions of futures markets, it has limited value to the portfolio manager because a zero-risk position is rarely optimal. The manager may want to use futures to alter portfolio risk without eliminating it. If so, what are the riskheturn characteristics of the portfolio? How can the portfolio's performance be evaluated?
Modern portfolio analysis measures performance to identify profitable investments. In this paper, strategies involving index futures contracts are examined using a standard performance evaluation technique-Sharpe's Rewardto-Volatility Index. Our purpose is, first, to demonstrate the impact on the portfolio distribution of various strategies using index futures and, second, to analyze the relevant factors that determine "better" performance. We find that the relevant factors are the risk-free rate, the basis, and the expected value of dividend payments.
'By adopting a single period model, we avoid intertemporal cash flow issues. have identified stochastic interest rates as a theoretically relevant variable with regard to futures pricing. In our model, the interest rate is a fixed market determined datum. Our purpose is not to explain futures prices but rather to examine the impact on the portfolio distribution of employing futures contracts. Extension of our model to the multiperiod or continuous time cases would be interesting, but that would be for another paper.