Say you are a portfolio manager with a competitive advantage in picking stocks, capable of generating alpha
Question:
Say you are a portfolio manager with a competitive advantage in picking stocks, capable of generating "alpha" (a- extra returns not explained by the risk in your portfolio). A client approaches you and ask for a lower risk strategy, but doesn't want to give up the your stock picking can generate. You tell your client this isn't a problem you can use forward contracts on the s & P 500 and bond to port your a to a bond return. Assume the continuously compounded risk free rate is 2% that the current spot price of one unit of S & P, the current value of the stock portfolio and the spot price of one treasury bond are all equal to $4500
Briefly explain how you could convert your stock return to bond return( assume a horizon/maturity of 1 year)
If expected effective annual return on the S&P (E(rsp)) is 8% your alpha = 3% and the expected effective annual return on your portfolio is E(rsp) + alpha what is the expected spot price in one year of your portfolio ? what is the expected spot price in one year of one unit of the S&P 500?
What should the forward price be for one unit of the S&P?
What should the forward price be for one Treasury Bond?
If the future spot price of the treasury bond is $ 4950 what is the expected total value of your position from part a) in one year time.
What is the effective annual return on this strategy?
Corporate Finance A Focused Approach
ISBN: 978-1305637108
6th edition
Authors: Michael C. Ehrhardt, Eugene F. Brigham