1. What is the value of the contract in terms of the index?

2. How many contracts would DeLuca have to sell to hedge $1,000,000? Why should DeLuca sell rather than purchase the contracts?

3. How much cash will DeLuca have to put up to meet the margin requirement? If the annual interest rate on money market securities is 6 percent, what is the interest lost from the margin requirement if the position must be maintained for two months?

4. If the market declined by 5 percent, what will happen to the value of the contracts? Could DeLuca take funds out of the position to reduce the interest lost?

5. If the beta of his portfolio is 1.0 and the market declines by 5 percent, how much would he lose on a $1,000,000 portfolio?

6. If the beta of the portfolio were less than 1.0, could DeLuca hedge his position by selling fewer contracts? If the beta were 0.75, how many contracts would be necessary to hedge the portfolio?

7. Suppose the beta of the portfolio is 0.75 and DeLuca sells 15 contracts. The market then rises by 10 percent; what are the profits and losses on the portfolio and on the contracts? What is the net profit or loss?

8. When the contracts expire, will DeLuca have to deliver the securities he owns to cover the contracts?

9. Does the strategy of using futures contracts achieve its objective?

One of your most sophisticated investors, Joseph DeLuca, believes that the stock market will decline and hence reduce the value of his substantial portfolio. However, he does not want to sell the stocks, because the sales would generate a substantial federal capital gains tax liability in the current tax year. He recently read that futures may be used to reduce the risk of loss from price changes as well as vehicles designed to speculate on price changes. You have been his personal financial planner for many years, and he has asked you to develop a strategy using futures to achieve his goal of protecting his gains without selling the securities in the current year.