Simon Hashton is a principal in the firm Wellington Financial Consultancies. Since last thirty years he was CFO with Simphon Investments, the investment window with First State Bank of Carolina. He left the bank in June 2018 with an intention to turn expertise into greater personal benefits.

During his recent agenda, two portfolios are under management for medium-sized pension funds. The first one is an index fund considering a cross section of the S&P 500 stocks. This portfolio had been constructed as a primary portfolio for the North Fold Crakerdons, currently 10 million. The second portfolio is an actively managed fund for the Robin Cooperative Retirement Fund, with a total of 2.75 million.

The Crakerdons portfolio was put in a cross-section of S&P 500 stocks on December 23, 2018, when the S&P 500 Stock Index closed at 500. An year later, on December 20, 2019, the S&P 500 Index closed at 595. On the same day the S&P 500 March/2020 futures contract closed at 600. The March/600 call on the S&P 500 March/2020 futures contract closed at 600. The March/600 call on the S&P 500 Index carried a premium of 18.75 points, & the March/600 put was at 8.50. The Robin Retirement fund was allocated as follows: cash equivalents, 9%; fixed-income securities, 36%; equities, 55%. Treasury-bond futures were priced at 95.

On Dec 20, 2019, Mr. Simon reached his office with an intention to adjust these two portfolios. Nevertheless, he was skeptical about the stock market. On one side, he believed the stock market may endure its advance from an S&P 500 level of 595 to an index level of 640 during the next 3 months if the corporate profits remained their upward surge. On the other side, he is also concerned that a downward correction could take the market to 545 if interest rates fluctuate drastically, as some analysts were forecasting. After contemplating his options, he decided to consider alternative strategies for both funds, ignoring taxes & transaction costs for simplification of his task.

1. Assume Mr. Simon thinks that the stock market will get bearish and he wants to lighten, but also not eliminate his equity position & increase the fixed income part of the Robins portfolio.

Suggest suitable actions he can take in the futures markets to shift the allocation of the Robins portfolio to zero cash, 1.6 million fixed-income, & 1.15 million equities. (15 Marks)

2. Is S&P 500 March stock index future fairly priced on Dec 20? Explain (Yield Percent: Treasury-bills, 8%; S&P 500, 4%) (5 Marks)

3. Which of the following risk management strategies would you suggest for the Crakerdons portfolio under the conditions in (a) & (b) below and why? (10 Marks)

1. Assume the chances of the market going up to 640 were 20% and the chances of the market falling to 545 were 80%.
2. Assume the chances of the market going up to 640 were 60% and the chances of the market falling to 545 were 40%.

1. Do nothing
2. Liquidate the portfolio
3. Sell March futures
4. Buy March/600 put
5. Sell March futures & buy March/600 calls
6. Sell March/600 calls