Case Problem 15 2 questions A D (page 623) Excel Investing One of the unique features of futures contracts is that they have only one source of returnthe capital gains that can accrue when price movements have an upward bias Remember that there are no current cash flows associated with this financial asset These instruments are known for their volatility due to swings in prices and the use of leverage upon purchase With futures trading done on margin, small amounts of capital are needed to control relatively large investment positions Assume that you are interested in investing in commodity futuresspecifically, oats futures contracts Refer to the contract terms of oats OATS (CBOT) 5000 bu cents per bushel Suppose you had purchased 5 December oats contracts at the settlement price of 186 75 The required amount of investor capital to be deposited with a broker at the time of the initial transaction is 5 35 of a contracts value Create a spreadsheet to model and answer the following questions concerning the investment in futures contracts Questions Explain why the Pernellis would want to use stock index futures to hedge their stock portfolio and how they would go about setting up such a hedge Be specific What alternatives do Jim and Polly have to protect the capital value of their portfolio What are the benefits and risks of using stock index futures to hedge Assume that S P MidCap 400 futures contracts are priced at $500 the index and are currently being quoted at 769 40 How many contracts would the Pernellis have to buy (or sell) to set up the hedge Say the value of the Pernelli portfolio dropped 12 over the course of the market retreat To what price must the stock index futures contract move in order to cover that loss Given that a $16,875 margin deposit is required to buy or sell a single S P 400 futures contract, what would be the Pernellis return on invested capital if the price of the futures contract changed by the amount computed in questionb1 Assume that the value of the Pernelli portfolio declined by $52,000 while the price of an S P 400 futures contract moved from 769 40 to 691 40 (Assume that Jim and Polly short sold one futures contract to set up the hedge ) Add the profit from the hedge transaction to the new (depreciated) value of the stock portfolio How does this amount compare to the $375,000 portfolio that existed just before the market started its retreat Why did the stock index futures hedge fail to give complete protection to the Pernelli portfolio Is it possible to obtain perfect (dollar for dollar) protection from these types of hedges Explain The Pernellis might decide to set up the hedge by using futures options instead of futures contracts Fortunately, such options are available on the S P MidCap 400 Index These futures options, like their underlying futures contracts, are also valued priced at $500 times the underlying S P 400 Index Now, suppose a put on the S P MidCap 400 futures contract (with a strike price of 769) is currently quoted at 5 80, and a comparable call is quoted at 2 35 Use the same portfolio and futures price conditions as set out in questioncto determine how well the portfolio would be protected if these futures options were used as the hedge vehicle (Hint Add the net profit from the hedge to the new depreciated value of the stock portfolio ) What are the advantages and disadvantages of using futures options, rather than the stock index futures contract itself, to hedge a stock portfolio

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Jun 10, 2024

Case Problem 15.2 questions A-D (page 623) Excel@Investing One of the unique features of futures contracts is that they have only one source of returnthe

Case Problem 15.2 questions A-D (page 623)

Excel@Investing

One of the unique features of futures contracts is that they have only one source of returnthe capital gains that can accrue when price movements have an upward bias. Remember that there are no current cash flows associated with this financial asset. These instruments are known for their volatility due to swings in prices and the use of leverage upon purchase. With futures trading done on margin, small amounts of capital are needed to control relatively large investment positions.

Assume that you are interested in investing in commodity futuresspecifically, oats futures contracts. Refer to the contract terms of oats: OATS (CBOT) 5000 bu.; cents per bushel. Suppose you had purchased 5 December oats contracts at the settlement price of 186.75. The required amount of investor capital to be deposited with a broker at the time of the initial transaction is 5.35% of a contracts value. Create a spreadsheet to model and answer the following questions concerning the investment in futures contracts.

Questions

Explain why the Pernellis would want to use stock index futures to hedge their stock portfolio and how they would go about setting up such a hedge. Be specific.
1. What alternatives do Jim and Polly have to protect the capital value of their portfolio?
2. What are the benefits and risks of using stock index futures to hedge?
Assume that S&P MidCap 400 futures contracts are priced at $500 the index and are currently being quoted at 769.40. How many contracts would the Pernellis have to buy (or sell) to set up the hedge?
1. Say the value of the Pernelli portfolio dropped 12% over the course of the market retreat. To what price must the stock index futures contract move in order to cover that loss?
2. Given that a $16,875 margin deposit is required to buy or sell a single S&P 400 futures contract, what would be the Pernellis return on invested capital if the price of the futures contract changed by the amount computed in questionb1?
Assume that the value of the Pernelli portfolio declined by $52,000 while the price of an S&P 400 futures contract moved from 769.40 to 691.40. (Assume that Jim and Polly short sold one futures contract to set up the hedge.)
1. Add the profit from the hedge transaction to the new (depreciated) value of the stock portfolio. How does this amount compare to the $375,000 portfolio that existed just before the market started its retreat?
2. Why did the stock index futures hedge fail to give complete protection to the Pernelli portfolio? Is it possible to obtain perfect (dollar-for-dollar) protection from these types of hedges? Explain.
The Pernellis might decide to set up the hedge by using futures options instead of futures contracts. Fortunately, such options are available on the S&P MidCap 400 Index. These futures options, like their underlying futures contracts, are also valued/priced at $500 times the underlying S&P 400 Index. Now, suppose a put on the S&P MidCap 400 futures contract (with a strike price of 769) is currently quoted at 5.80, and a comparable call is quoted at 2.35. Use the same portfolio and futures price conditions as set out in questioncto determine how well the portfolio would be protected if these futures options were used as the hedge vehicle. (Hint:Add the net profit from the hedge to the new depreciated value of the stock portfolio.) What are the advantages and disadvantages of using futures options, rather than the stock index futures contract itself, to hedge a stock portfolio?