Pigeon Ltd holds a well-diversified portfolio of shares with a current market value on 1 May 2014 of $900 000.On this date Pigeon Ltd decides to hedge the portfolio by taking a sell position in ten SPI futures units.The All Ordinaries SPI is 2980 on 1 May 2014.A unit contract in SPI futures is priced based on All Ordinaries SPI and a price of $25.The futures broker requires a deposit of $1500.On 30 June the All Ordinaries SPI has fallen to 2570 and the value of the company's share portfolio has fallen to $790 000.What is the gain or loss on the futures contract and the net gain or loss after hedging?
A) loss on futures contract $102 500; net gain after hedging $6000
B) gain on futures contract $10 250; net loss after hedging $99 750
C) gain on futures contract $102 500; net loss after hedging $7500
D) gain on futures contract $164; net loss after hedging $109 836

Question

Quizplus · Accepted Answer

The gain on the futures contract is calculated based on the change in the SPI value and the contract size. The SPI fell from 2980 to 2570, a decrease of 410 points. Each futures contract is based on a $25 multiplier, so the gain per contract is 410 * $25 = $10,250. With ten contracts, the total gain is $10,250 * 10 = $102,500. The portfolio fell in value from $900,000 to $790,000, a loss of $110,000. The net loss after hedging is the portfolio loss minus the futures gain: $110,000 - $102,500 = $7,500.

Pigeon Ltd Holds a Well-Diversified Portfolio of Shares with a Current