USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider a portfolio manager with a $20,500,000 equity portfolio under management. The manager wishes to hedge against a decline in share values using stock index futures. Currently a stock index future is priced at 1250 and has a multiplier of 250. The portfolio beta is 1.25.
-Refer to Exhibit 15.10. Calculate the overall profit.
A) $1,550,000
B) -$2,000,000
C) $2,050,000
D) -$5,000,000
E) $2,400,000

Question

Quizplus · Accepted Answer

The correct answer is A. The portfolio manager should sell 16,400 futures contracts (20,500,000/1,250,000 * 1.25 * 250). If the stock index falls by 10%, the futures will gain 12.5% (10% * 1.25). The profit on the futures will be 16,400 * 250 * 12.5% = $5,100,000. The loss on the portfolio will be 20,500,000 * 10% = $2,050,000. The overall profit will be $5,100,000 - $2,050,000 = $3,050,000.