Question Four (17 Marks) Consider a U.S. portfolio manager who holds a portfolio of Spanish stocks currently worth 1 million. In order to hedge against a potential depreciation of the euro, the portfolio manager proposes to sell December futures contracts on the euro that currently trade at $l/ and expire in two months. The spot exchange rate is currently $1.2/. A month later, the value of the Spanish portfolio is 1,050,000 and the spot ex- change rate is $1.1/6, while the futures exchange rate is $0.895/. a. Evaluate the effectiveness of the hedge by comparing the fully hedged portfolio return with the unhedged portfolio return (13 Marks) Page 3 of 10 b. Calculate the return on the portfolio, assuming a 50 percent hedge ratio. Explain the difference in the return compared to the fully hedged portfolio. (4 Marks)