A US investor has a $50 Million dollar Stock Portfolio. The investor is worried about a declining market.  The following information is provided:

Beta of the stock portfolio is 1.25
 
S&P 500 Index at the beginning of the year is 1,500. Investor is worried the S&P 500 index may decline to 1,200 by the end of the year.

Value of 1 S&P 500 contract is $250.

1. Describe how the US investor can hedge against a decline in their stock portfolio if the market decreases as expected. No calculations are required.

2. Calculate the expected percentage decrease in the market anticipated by the US investor.  

3. Calculate the dollar amount at risk (loss in portfolio value) if the market decreases as expected.    

4. Calculate the hedge ratio.      

5. If the market declines exactly by the amount expected and the investor executed the hedge at the beginning of the year, what is the dollar amount of the loss in the portfolio?  Explain?

Answer rating: 100% (QA)

ANSWER Hedging against a decline in the stock portfolio can be achieved by using SP 500 futures contracts The investor can sell SP 500 futures contracts to offset the potential losses in their portfol... View the full answer