A portfolio manager in charge of a portfolio worth $10 million is concerned that the market might decline rapidly during the next six months and would like to use put options on an index to provide protection against the portfolio falling below $9.5 million.The index is currently standing at 500 and each contract is on 100 times the index.What should the strike price of options on the index be the portfolio has a beta of 0.5? Assume that the risk-free rate is 10% per annum and there are no dividends.
A) 400
B) 410
C) 420
D) 425

Question

Quizplus · Accepted Answer

The risk-free rate per six months is 5%.When the portfolio declines by 5% its return per six months is 10% below the risk-free rate.The return on the index is therefore 20% below the risk-free rate.Its return is therefore −15%.The portfolio therefore declines to 500×0.85 = 425.

A Portfolio Manager in Charge of a Portfolio Worth $10