Q4. (a)

Investors can use financial futures, like stock-index futures, for hedging, spreading, and speculating. Discuss how stock-index futures can be used by individual investors and portfolio managers for speculation and hedging. What advantages are there to speculating with stock-index futures rather than specific issues of common stock? (14 marks)

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(b) Chris just purchased 500 shares of ABC at RM21.50 and he has decided to hedge the shares through buying put option. Accordingly, he buys 500 ABC puts at a cost of RM1.25 per put. The puts have 3 months to expiration and carry a strike price of RM22. The stock pays a quarterly dividend of RM0.50 a share (the next dividend to be paid in about a month).

(i) What happens to Chris profit/loss if the price of the stock drops to RM19.50? (6 marks)

(ii) What is the break-even point (stock price) of this hedging? Explain the meaning of this figure. (3 marks)

(iii) Will you advise Chris to use this puts hedging? Comment. (2 marks) [Total : 25 marks]