1. James Bond manages an equity portfolio valued at 100,000,000 British pounds. The beta of the portfolio is currently -0.5. Bond seeks to hedge the portfolio against systematic risk using FTSE100 index futures contract from October 17, 2014 to December 17, 2014. He decides that over the coming two months a portfolio expected return equal to the risk-free rate of interest is adequate given the overall market conditions. As the analyst assisting the fund manager, you are given the following information:

• FTSE100 spot index as of October 17, 2014 = 5,190
• December FTSE100 index futures price as of October 17, 2014 = 5,250.
• Each futures contract is on 10 British pounds times the index
• Correlation between the FTSE100 spot returns and FTSE100 futures returns = 1
• FTSE100 futures return standard deviation = 1.00
• FTSE100 spot return standard deviation = 1.00

Which of the following is the most appropriate strategy you would recommend James Bond to do in order to achieve his hedging objective stated above (round number of contracts to the nearest integer)?

a) Short 985 futures contracts

b) Short 952 futures contracts

c) long 1926 futures contracts

d) Short 1905 futures contracts

e) Long 952 futures contracts

2. On July 5, a stock index futures contract with expiration on December 20 settles at 390.84. On the same day, the spot index closes at 392.54. Assume that each index point is worth $1. The risk-free rate of interest is 1.5% per annum and the dividend yield on the spot index is 3.5% per annum (both rates are continuously compounded). Transaction costs are negligible. Then:

a) Go long the futures, short the spot, invest the proceeds and realize an arbitrage profit of $1.88

b)Go short the futures, borrow to long the spot and realize an arbitrage profit of $1.88

c) The futures and the spot are fairly priced and, hence, there is no arbitrage opportunity

d) Go short the futures, borrow to long the spot and realize an arbitrage profit of $1.70

e) One cannot tell if there is an arbitrage opportunity or not, as we dont know what the spot price of the index will be at the expiration of the futures contract