It is the 1st of June. A company has a portfolio of stocks worth 200 million. The beta of the portfolio is 1.30. The company would like to use the FTSE 100 index futures contract to hedge the portfolios exposure to the market. The index future price is 6,500 and each contract is on 10 times the index.

a) What strategy should the company take if they wish to hedge the portfolios exposure to the stock market? Show the number of derivatives needed and explain how the proposed hedging strategy works by drawing a diagram displaying the relationship between the value of the portfolio and the FTSE100 index.

(8 marks)

b)Suppose that the company has changed its mind and decides to increase the beta of the portfolio from 1.30 to 1.60. What position in the futures contracts should they take

and how many contracts are needed?(4m)

c) Explain how derivatives can be used for either hedging or speculation, with particular reference to your answers to question 6a) and 6b).

(6 marks)

d) Discuss what measures can be taken by the company in question to make sure that a hedger does not become a

speculator. (7 marks)