A fund manager has exposure to Malaysian stocks and intends to keep his position in the stocks since he thinks the underlying fundamentals are good. However, he is worried about volatility that could erode the current value of his portfolio.

The following information is available to you today:

• Current value of portfolio = RM3,325,000;

• Risk-free rate = 6% per year

• Dividend yield on portfolio = 2.5% annualised

• Spot index value = 1,850 points

• Six months stock index futures (SIF) futures contract = 1,865.00 points;

• Assume the futures will expire in exactly 90 days; and

• Beta of portfolio = 1.70

You are required to assist the fund manager.

1. Should the fund manager buy or sell futures contract? (2 marks)

2. How many futures contracts should the fund manager buy or sell? (4 marks)

3. What is the outcome of the recommended hedging strategy above? (4 marks)

4. Illustrate by way of a payoff diagram the outcome of the above hedging strategy. (5marks)