Q5) On 9th March you decide to divest a segment of your fund portfolio by the end of the month. That segment corresponds to a broadly held equity portfolio that closely follows the S&P200 Index i.e. the portfolio beta with the S&P200 Index is 1, and its current market value is $6.165m. Until the segment is liquidated, you attempt to fully hedge against downside risk using ASX S&P200 index futures (1 point = $25). Relevant details are:
On 9th Mar | On 30th Mar | |
Portfolio value | $6.165m | $5.84m |
ASX S&P200 Index | 3322.6 | 3148.8 |
ASX S&P200 Futures | 3349 | 3115 |
Describe in detail how you would construct a hedging position, assuming the above details occur on 30th March. a) Evaluate the outcome of your hedge. b) Carefully outline a possible reason (other than rounding up contracts) for a possible discrepancy between the spot and hedging positions.
a) On 9th March:
Value of portfolio = $6.165m
ASX S&P 200 Future price = $3349*25 = $83725
Since the portfolio has a beta of 1 with respect to S&P 200 index. It is a perfect hedge and should have the hedge ratio of 1
For each dollar in portfolio short equal dollars in ASX S&P 200 Future.
Hence you would short = $6,165,000/83725 units = 73.63 units or 73 units
b)
On 30th March:
Value of portfolio = $5.84m
ASX S&P 200 Future price = $3115*25 = $77875
Profit from future = 73*($83725 - $77875) = $427,050
Loss on the portfolio = $6,165,000- $5,840,000 = $325,000
Total change in the hedged portfolio = $427,050 - $325,000 = $102,050
b) The difference between spot and hedging position is mostly because of:
1) Basis risk = the future price will not change exactly as its underlying
2) Fractional trading is not allowed. hedge ratio was 73.63 we hedge with 73.
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