Jean Paul’s father, a famous French businessman, left him €4 million. Jean Paul invested that money in the French stock market, investing in 20 of the largest capitalization stocks in France. Today, that portfolio is worth €4.5 million. Jean Paul wants to keep his portfolio intact, but he is concerned about a market downturn. He decides, therefore, to hedge his position with six-month futures currently trading at 5,539 on the CAC 40 Index.

a. Why would he choose to hedge his position with the futures in the CAC 40?

b. Given that Jean Paul wants to use up the full €4.5 million in his portfolio, describe how this hedge would be set up.

c. If each contract required a margin deposit of €4,300, how much money would he need to set up the hedge?

d. Assume that over the next six months, French stocks do fall, and the value of Jean Paul’s portfolio drops to €4 million. If CAC 40 Index futures are trading at 5,000, how much will he make (or lose) on this futures hedge? Is it enough to offset the loss in his portfolio?

e. Will he now get his margin deposit back, or is that a “sunk cost”–gone forever?