You hold $100 million worth of the S&P500 (spot asset) and you consider hedging your market exposure using S&P500 futures. The daily distribution of the returns on the spot and the futures are as follows:

Spot: follows the normal distribution with mean=0.0%, standard deviation=0.55%

Futures: follows the normal distribution with mean=0.0%, standard deviation=0.60%

The correlation coefficient is 0.80.

1. Calculate and interpret the minimum variance hedge ratio.
2. Calculate the risk (sigma) of the hedged portfolio. (Hint: weights of the hedged portfolio will be h/(1+h) for futures, 1/(1+h) for spot asset.)
3. Calculate the daily $VAR for the unhedged portfolio at the 99% confidence level.
4. Calculate the daily $VAR for the hedged portfolio at the 99% confidence level.

Answer rating: 100% (QA)

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