a) An investor has a $80 million portfolio with a beta of 1.3 and plans to use 3-month futures contracts on the ASX200 to hedge the risk of the portfolio over the next 2 months. The current level of the market index is 7,000, one contract is on 25 times the index, the risk-free rate is 6% per annum. The current 3-month futures price is7,250.

 

Required:

(i) What position should the investor take to eliminate all exposure to the market over the next two months? Show all working. 

 

(ii) Calculate the effect of your strategy (that you calculated in part (i)) on the investor's returns if the level of the market index in two months' time is 6,500, assuming that the futures price is 0.5% higher than the index level at this time. Comment briefly on how well your hedging strategy worked. In your answer show the gain (or loss) on both the futures position and the portfolio position (spot) and calculate the net position (ie. value) of the portfolio as a result of the hedging strategy. Show all working. Use dot points where necessary.