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Q5) On 9th March you decide to divest a segment of your fund portfolio by the...

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.

Homework Answers

Answer #1

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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