QUESTION 2: (2 points each section, a total of 6 points) (a) Your analysis predicts that energy stocks will outperform the stock market in the next year, with an alpha of 5% relative to the S&P 500. You, therefore, invest $65 million in a portfolio that tracks the Energy Sector Index. The portfolio, however, has a beta of 0.85 and you are concerned that the total return would be unsatisfactory if the stock market rose. You, therefore, decide to use futures contracts to increase the beta to 1.00. There is a futures contract the S&P 500 Index, and its size is $250 times the value of the index. The current futures price is $1300 and its beta is 1.00. Design the optimal strategy. In the parts below, assume that everything behaved the way you estimated. In particular, use beta of 0.85 and alpha of 5% for your stock portfolio, and beta of 1.00 for the futures contract. For simplicity, assume in the calculations that the riskless interest rate is zero (put differently, all the returns below are in excess of the risk free rate). (b) Suppose that the stock market ROSE by 10 percent. Calculate: the rate of return and the dollar gains or losses on your portfolio, the dollar gains or losses on your futures position, and the total dollar gains or losses. What is your rate of return relative to the S&P 500? (Hint: Stocks with beta of 0.85 and zero alpha, will increase by 8.5%.) Suppose that the stock market FELL by 10 percent. Calculate: the rate of return and the dollar gains or losses on your portfolio, the dollar gains or losses on your futures position, and the total dollar gains or losses. What is your rate of return relative to the S&P 500? QUESTION 2: (2 points each section, a total of 6 points) (a) Your analysis predicts that energy stocks will outperform the stock market in the next year, with an alpha of 5% relative to the S&P 500. You, therefore, invest $65 million in a portfolio that tracks the Energy Sector Index. The portfolio, however, has a beta of 0.85 and you are concerned that the total return would be unsatisfactory if the stock market rose. You, therefore, decide to use futures contracts to increase the beta to 1.00. There is a futures contract the S&P 500 Index, and its size is $250 times the value of the index. The current futures price is $1300 and its beta is 1.00. Design the optimal strategy. In the parts below, assume that everything behaved the way you estimated. In particular, use beta of 0.85 and alpha of 5% for your stock portfolio, and beta of 1.00 for the futures contract. For simplicity, assume in the calculations that the riskless interest rate is zero (put differently, all the returns below are in excess of the risk free rate). (b) Suppose that the stock market ROSE by 10 percent. Calculate: the rate of return and the dollar gains or losses on your portfolio, the dollar gains or losses on your futures position, and the total dollar gains or losses. What is your rate of return relative to the S&P 500? (Hint: Stocks with beta of 0.85 and zero alpha, will increase by 8.5%.) Suppose that the stock market FELL by 10 percent. Calculate: the rate of return and the dollar gains or losses on your portfolio, the dollar gains or losses on your futures position, and the total dollar gains or losses. What is your rate of return relative to the S&P 500