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22 April, 12:17

On July 1, an investor holds 50,000 shares of a certain stock. The market price is $30 per share. The investor is interested in hedging against movements in the market over the next month and decides to use an index futures contract. The index futures price is currently 1,500 and one contract is for delivery of $50 times the index. The beta of the stock is 1.3. What strategy should the investor follow?

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  1. 22 April, 14:11
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    The strategy the investor should follow is to short 26 contracts of September Mini S&P 500 futures.

    Explanation:

    Provided information;

    Amount of shares of a certain stock = 50,000

    The market value per share = $30

    Portfolio value = P = 50,000 * 30 = $1,500,000

    Beta of stock β = 1.3

    current Index futures price = 1,500

    Multiplier = $50

    Futures Value A = 1,500 * 50 = $75,000

    The formula used in calculating the number of contracts =

    Number of contracts N = (β * P) : Future values

    N = (1.3 * $1500000) : $75000

    N = $1950000 : $75000

    Number of contracts N = 26

    The strategy the investor should follow is to short 26 contracts of September Mini S&P 500 futures.
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