You manage a diversified portfolio with a beta of 1.4 vs the S&P 500 index. You want to hedge against a market decline and are willing to forego upside participation. With the cash index at 1860 your portfolio is valued at $5, 180,000; dividend yield on the S&P 500 index is 2% and the three-month T-Bill yield is 0.6%. The futures multiplier is 250, and the options multiplier is 100.

Given the following futures and options products

-3-month S&P 500 futures trading at 1850 index points

-3 months 1870 call priced at 35 index points

-3 months 1870 put priced at 65 index points

Answer the following questions:

a. Construct two ways of hedging the portfolio. (4 marks)

b. Calculate the gains and losses on the futures position for cash index expiration value at 50

point intervals between 1700 and 1900. (5 marks)

c. Calculate the gains and losses on the synthetic hedge position for cash index expiration value at 50 point intervals between 1700 and 1900.(5 marks)

d. Which strategy will you choose? Why? potential, what should be your strategy?

e. If you want to hedge against a market decline and unwilling to forgo upside potential, what is your strategy?

Answer rating: 100% (QA)

a Construct two ways of hedging the portfolio 4 marks ANSWER Hedge 1 Sell short 3month SP 500 futures contract at 1850 index points Buy 3 months 1870 ... View the full answer