Question

In early March an insurance company portfolio manager has a stock portfolio of $500 million with a portfolio beta of 1.20. The portfolio manager plans on selling the stocks in the portfolio in June to be able to pay out funds to policyholders for annuities, and is worried about a fall in the stock market. In April, the CME Group S&P 500 mini= Futures contract index is 2545 for a June futures contract ($50 multiplier for this contract).   

a. What type of futures position should be taken to hedge against the stock market going down and how many future contracts are needed for this hedge? [Hint: # contracts = [Portfolio x Beta] /[ Futures Index Price x Multiplier]              \

Type of Position __ Position_____

            Explain why __________________________

                      

How many contracts should you get? Number of Contracts_______________

Answer 1

In order to hedge i.e. to protect against price risk, we must
take position in future market, which is opposite to the
position in the spot market.
In the current scenario, portfolio manager have short sell
position in the spot market, so he must go long (bought)
in the future market.
Contracts needed for hedge
= (Amount of Portfolio * Beta of Portfolio) / (Futures Contract Index * Multiplier)
= ($500,000,000 * 1.20) / ($2545 * $50)
= $600,000,000 / $127250
= 4715.13
Approx. 4715 Contracts