A fund manager has a portfolio worth $50 million with a beta of 1.35. The manager is concerned about the performance of the market over the next three months and plans to use four-month Mini S&P 500 futures contract to hedge the risk. The current level of the index is 1,560, the risk-free rate is 0.60% per annum, and the dividend yield on the index is 1.7% per annum. The current four-month futures price is 1,555. One futures contract covers $50 times the index.

1. What position should the fund manager take to eliminate all exposure to the market over the next three months?

Solution:

Number of contracts to hedge = 1.35*$50000000/1560/250=173.07

Thus, rounding to the nearest whole number, the investor should short 173 contracts to eliminate exposure to the market.

2. Calculate the effect of your strategy on the fund manager