Darling Downs Investors Ltd (DDI) runs a portfolio whose performance is like the performance of the Australian share market as measured by the S&P/ASX 200 index. DDI would like some protection against a possible near-term market collapse but would like to avoid incurring the transaction costs of selling the holdings in the portfolio and then buying them back in the future. Assume that the market is liquid and that there are several derivative contracts based on the ASX 200 index.

A) What kind of positions in the option market would offset at least some of the risk of a market collapse? Briefly explain, using long or short terminology as appropriate. (3 marks)

B) Assume you have hedged with options. Briefly indicate what happens to your portfolio if the market does not collapse and stays level over the relevant period. Briefly explain. (3 marks)

C) What kind of positions in the futures market would offset the risk of a market collapse? Briefly explain, using long or short terminology as appropriate. (3 marks)

Answer rating: 100% (QA)

A To offset at least some of the risk of a market collapse DDI can consider taking the following pos... View the full answer