A hedge fund manager has a portfolio worth $50 million with a beta of 1.25. The manager is concerned about the performance of the market over the next two months He plans to uses three-month stock market index futures to hedge his market exposure. The current stock market index level is 2,500 and one contract is on 250 times the futures price. The continuously compounded interest rate is 3% and the dividend yield on the stock market index is 2%.

a) What is the fair futures (forward) price today?

b) What position should the fund manager take to hedge his market exposure?

c) Calculate the effect of the hedging strategy on the fund managers return if the index in two months is 2,250, 2,500, or 2,750. (Hint: For each scenario, compute the fair forward price with one month maturity left and same interest rate and dividend yield. Then, you can compute the total profits or losses he incurs on his hedging position.)