Question

You manage an MYR12 million portfolio with KLCI stocks, and believe that the market is on the verge of a big but short-lived downturn. You are thinking to fully hedge your portfolio’s equity position for that short term volatility.

a. Should you long or short KLCI futures contracts?

b. If your equity holdings are invested in a market-index fund, into how many contracts should you enter?

c. How does your answer change to (b) if the beta of your portfolio is 0.6.

Answer 1

a) You should short the KLCI future contracts

Because if market is falling then we should short the futures contratcs, means first we will sell at high price and then as market falls we will buy back at low price. As profit is difference between sell and buy price, we will make profit.

b) Here I have taken Malaysian stock exchange trading rate and contact size as on date.(It will change everyday)

Today index trading at 1,691 and contract is RM 50 times the index.

So each contract controls worth 1,691*50= RM 84550 or malaysian ringits

We have 12 million MYR so 12 million/84550 = 141.92

It means 142 contracts

c) if beta is 0.6 then your stcok volatality is only 0.6 so 0.6*142= 85.2

It means now you only need 85 contracts.

Here the above values will change acording to index valuation. So please understand the process, numbers can be changed.