Financial Engineering Individual Coursework $2024$

As a newly employed analyst at a hedge fund. You are allocated a portfolio to manage. The portfolio consists of $30$ stocks, it is valued at $$300,000$ on $30$th November $2023,$ and the portfolio is equally weighted on the date.

The hedge fund manager has asked you to complete the following task:

Task $1$:

Track performance of the portfolio from $1$st December $2023$ to $31$st January $2024.$ Report daily portfolio value, daily portfolio return, holding period return, standard deviation of daily returns and value of risk of the portfolio. Discuss risk characteristics of the portfolio.

Task $2$:

Identify a futures contract as a hedging instrument to reduce risk of the portfolio. The aim is to achieve perfect hedge as much as possible, so the hedged position has minimum risk. The manager wants to know which futures contract you choose, and why is it chosen to hedge the portfolio? He also want to know the rationale of the choice, you need to demonstrate it quantitatively.

Task $3$:

Using the identified instrument from pervious section, hedge the portfolio between $1$st February $2024$ and $29$th March $2024.$ Compare performance of portfolio when it is hedged and unhedged. Report daily portfolio value, daily portfolio return, holding period return, standard deviation of daily returns and value of risk for both hedged and unhedged positions. Evaluate effectiveness of the hedge and discuss why or why not the hedge is effective.

Task $4$:

Rather than trying to achieve perfect hedge, identify an option contract to protect against downside risk, so the portfolio value does not drop more than $20\%.$ Details of the option contract should be identified, e$.$g$.$ strike price, maturity, etc. Discuss why the underlying asset is chosen.

Task $5$:

The same downside risk protection can also be achieved dynamically trading futures contracts, discuss this strategy and identify a futures contract to implement the strategy. For period between $1$st February $2024$ and $29$th March $2024,$ evaluate and compare performance of the portfolio when protection is bought from options and futures. Discuss and compare effectiveness of the two protection strategies. Comment on which one is more costly to run. Calculate and compare value at risk of the portfolio for each strategy.

Task $6$:

In addition to the allocated portfolio, the hedge fund manager also provided you with $$50,000$ of cash. You are asked to design an option trading strategy to maximise profit in the next two month. The strategy should consist of at least two option contracts. Identify and explain your option choices, discuss rationale of the strategy. Backtest the option strategy from $1$st February $2024$ to $29$th March $2024.$ Discuss performance of the strategy, what is the trading period return? What risk is involved? why is the strategy profitable? Why not?