Question 3

Portfolio insurance is an important risk management method in the management of stock portfolios.

(a) Differentiate between strategies used for portfolio insurance.

(b) A large blue chip fund holds a well-diversified portfolio spanning stocks from the major sectors of the US industries. Suppose the S&P 500 index is currently at 1900, the portfolio is worth $500 million and has a beta of 1.7, and the risk- free rate, the dividend yield on both the portfolio and the index are all 2.5% per annum. Find appropriate options to buy to protect the portfolio from falling below $450 million in 1 years time.