The following is part of the computer output from a regression of monthly returns on Waterworks stock

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The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 Index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month.
Standard Devlation of Residuals Beta R-square 0.06 (i.e., 6% monthly) 0.75 0.65

a. If he holds a $6 million portfolio of Waterworks stock and wishes to hedge market exposure for the next month using one-month maturity S&P 500 futures contracts, how many contracts should he enter? Should he buy or sell contracts? The S&P 500 currently is at 2,000 and the contract multiplier is $250.
b. What is the standard deviation of the monthly return of the hedged portfolio?
c.
Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month? Assume the risk-free rate is .5% per month.

Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest...
Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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Essentials of Investments

ISBN: 978-0077835422

10th edition

Authors: Zvi Bodie, Alex Kane, Alan J. Marcus

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