Suppose you wish to hedge a stock portfolio with an index futures contract. An increase in the quoted futures price of the index will _________ the number of futures needed for the hedge.
A) increase
B) decrease
C) Not change
D) increase only if the beta of the portfolio is greater than one
E) decrease only if the beta of the portfolio is greater than one

Question

Quizplus · Accepted Answer

An increase in the quoted futures price of the index indicates that the value of the index has increased, and therefore, the value of the portfolio has also increased. To maintain an effective hedge, the number of futures contracts needed to be sold to offset the portfolio's risk must be decreased, which will be achieved by buying fewer futures contracts. Therefore, an increase in the quoted futures price of the index will decrease the number of futures needed for the hedge.

Suppose You Wish to Hedge a Stock Portfolio with an Index