A fund manager has a portfolio worth $70 million with a beta of 0.92. The manager is concerned about the performance of the market over the next two months and plans to use three-month futures contracts on the S&P 500 to hedge the risk. The current level of the index is 3,400, one contract is on 250 times the index, the risk-free rate is 3% per annum, and the dividend yield on the index is 4% per annum. The current 3-month futures price is 3,430.

(a) What position should the fund manager take to eliminate all exposure to the market over the next two months? Explain carefilly and show clearly your calculations. [20%]

(b) Produce a table that calculates the effect of your strategy on the fund managers returns if the level of the market in two months is 3,200, 3,300, 3,400, 3,500, and 3,600. Assume that the one-month futures price is 0.25% higher than the index level at this time.