Question

You manage a portfolio worth $13.8 million, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to temporarily hedge your equity holdings with E-mini S&P 500 index futures contracts.
1) Should you be long or short the contracts? Why?
2) How many contracts should you enter into? The S&P 500 index futures price is now at 1286 and the contract multiplier is $250.
3) Suppose instead of reducing your portfolio beta all the way down to zero, you decide to reduce it to 0.5, how many index futures contracts should you enter into?

Answer 1

Answer:

1. According to the given data, he should be short the index contracts. In the event of stock value falling, he gets future profits to offset the loss from the falling price of the equity

2. You should enter into 42 contracts

3. You should enter into 21 contracts

Explanation:

1. According to the given data, he should be short the index contracts. In the event of stock value falling, he gets future profits to offset the loss from the falling price of the equity.

2. To calculate how many contracts should you enter, first we need to calculate the number of contracts required to hedge the portofolio as follows:

number of contracts required to hedge the portofolio as follows=$250×1,286

number of contracts required to hedge the portofolio as follows=$321,500

Therefore, number of contracts to hedge= portfolio worth/Each contract worth

number of contracts to hedge=$13.800.000/$321,500

number of contracts to hedge=42

You should enter into 42 contracts

3. If you decide to reduce portfolio beta to 0.5 the index futures contracts should you enter into is calculated as follows:

number of contracts to hedge= (portfolio worth/Each contract worth)×beta

number of contracts to hedge=($13.800.000/$321,500)×0.5

number of contracts to hedge=21

You should enter into 21 contracts