Kendall Investment Company just received information that General Pharmaceutical (GP) might be introducing a new acne drug in June. In response to the information, Kendall decided to buy 10,000 shares of GP, priced at \(P_{g}=\$ 50 /\) share and with a \(\beta\) of o.8. Kendall, however, is concerned that the market could decline by June, negating any increase in GP stock.

a. Explain how Kendall could construct a hedge with S\&P 500 futures contract expiring in June to reduce its exposure to systematic risk. Assume the current spot index and the futures contract are both 2,000 , with a 250 futures multiplier.

b. Evaluate the value of the stock and the futures for the following scenarios occurring one month later:

- There is a bull market and the new drug is introduced with \(S_{T}\) increasing to 2,250 and \(P_{g}\) to \(\$ 70\).

- There is a bear market and the new drug is introduced with \(S_{T}\) decreasing to 1,750 and \(P_{g}\) increasing to only \(\$ 55\).

c. Compare the periodic rates of return as a proportion of the stock investment \(((\$ 50)(10,000)=\) \(\$ 500,000)\) for each scenario that would result with and without the futures position.