You manage a $10 million portfolio, all invested in equities; the beta for your portfolio is 0.70. You believe the market is on the verge of a big but short-lived downturn; you would move your portfolio temporarily to T-bills, but you do not want to incur the transaction costs of liquidating and re-establishing your equity position. You decide to temporarily hedge your equity holdings with S&P 500 index futures contracts.

a) Should you be long or short the contracts?

b) How many contracts should you enter? (Assume the S&P index is at 1500 and the contract multiplier is $250.)

Question

Business

Aaron Terry

14 June, 21:41

You manage a $10 million portfolio, all invested in equities; the beta for your portfolio is 0.70. You believe the market is on the verge of a big but short-lived downturn; you would move your portfolio temporarily to T-bills, but you do not want to incur the transaction costs of liquidating and re-establishing your equity position. You decide to temporarily hedge your equity holdings with S&P 500 index futures contracts.

a) Should you be long or short the contracts?

b) How many contracts should you enter? (Assume the S&P index is at 1500 and the contract multiplier is $250.)

+1

Answers (1)

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Jaylen Trevino · Answer 1

a. You should short the contract to hedge the portfolio.

b. You should enter 19 contracts.

Explanation:

a) According to the given becuase we own portfolio (underlying), we need to sell future contracts in order to hedge. So short the contract to hedge the portfolio.

b. To calculate how many contracts should you enter we would have to use the following formula:

number of contract required = (beta * portfolio value) / (beta of futures"Index value * multiplier)

Therefore, N = 0.7*10,000,000 / (1*1500*250) = 18.67 = 19 contracts

You should enter 19 contracts