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You believe that the Canadian equity market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to hedge your portfolio with three-month S&P/TSX 60 index futures contracts for one month. Currently, the level of the S&P/TSX 60 index is 678.68, the three-month futures price of the S&P/TSX 60 is 665.60, and one contract is for $200 times the index. The annual simple risk-free rate of return is 1%.

1. You manage a portfolio that is currently all invested in equities in companies in five major Canadian industries. The market value involved and beta for each industry are shown in the table below. Industry Oil and Gas Technology Utilities Financial Pharmaceutical MV $1,000,000 600,000 1,500,000 800,000 1,300,000 Beta 1.2 1.5 0.8 1.3 1.1 You believe that the Canadian equity market is on the verge of a big but shortlived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to hedge your portfolio with three-month S&P/TSX 60 index futures contracts for one month. Currently, the level of the S&P/TSX 60 index is 678.68, the three-month futures price of the S&P/TSX 60 is 665.60, and one contract is for $200 times the index. The annual simple risk-free rate of return is 1%. a. How many futures contracts should you use? Long or short? (5 marks) b. Suppose the return on the S&P/TSX 60 index is -5% in one month, and the S&P/TSX index futures price falls to 620 in one month. Calculate your net gain or loss on your hedged portfolio in part (a). (10 marks)