Derivatives in Risk Management for a Pension Plan

Greenfield Investments is managing a defined benefit pension plan with a substantial allocation to equity markets. Due to recent geopolitical tensions and changing economic conditions, the plan’s sponsors are increasingly concerned about the potential for significant losses within their equity portfolio. You have been asked to propose a comprehensive risk management approach that incorporates the use of derivatives.

Your response should address the following elements:

1. Identify the types of derivative instruments that can be used to hedge equity exposure.
2. Discuss the advantages and disadvantages of using derivatives for this purpose.
3. Provide a detailed example of how derivatives might be implemented in this context, including calculations to illustrate the impact on the portfolio.

Lastly, conclude with a discussion on the overall effectiveness of derivatives in mitigating risk in a defined benefit pension plan, considering regulatory, liquidity, and potential counterparty risks.