returns. However, you are confident that you can isolate and capture the alpha you believe that selective hedge funds can generate. The difficulty is that you have been told by your supervisor $-$ the CFO $-$ that the firm currently has no allocation to alternative assets $-$ including hedge funds $-$ but is willing to consider approving an allocation only if the proposal is reasonable.

Using your knowledge of derivative financial assets, which was acquired in your business school studies, you have carefully designed and are about to recommend the following portable alpha strategy to replace the current bond index allocation. First, your pension

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fund can take a long position in $$150$ million of futures contracts on the Bond Index traded on the Chicago Mercantile Exchange $($CME$).$ Next, the $$150$ million of assets that have been allocated to the bond index portfolio can instead be transitioned $($shifted$)$ to a hedge fund manager. For this piece of the strategy you have identified a hedge fund that invests exclusively in stocks in the technology sector, and consistently beats its benchmark tech stock index by $200-250$ basis points $(2\mathrm{.}0-2\mathrm{.}5\%)$ per year on a risk$-$adjusted basis $($its alpha$).$ Finally, your pension fund should take a short position in $$150$ million of futures contracts on the Technology Sector Index, also traded on the CME. ${?}^{}$ The long and short futures positions will need to be rolled over each calendar quarter, but if executed properly this strategy should generate the excess returns that you are seeking to capture.

Explain this three$-$piece program by providing clear and concise answers to the following questions.

What two positions are effectively $($synthetically$)$ being taken with the long futures position on the Bond Index?

What two positions are effectively $($synthetically$)$ being taken with the short futures position on the Technology Sector Index?

Once the program is fully implemented, what net annual returns would you expect the pension plan to earn from this strategy? $($Your answer should be descriptive, not numerical.$)$

Why is it necessary to take a short position in the Technology Sector Index futures contract? $($Hint: This short position serves two purposes.$)$

What is the risk specific to futures trading that potentially will not make this program as effective as planned? What are some of the factors that create this risk that is unique to futures contracts?

Beyond the risk you identified in Question $5,$ what is the primary risk specific to portable alpha strategies that would cause them to under perform their benchmark, and possibly even suffer significant losses?