The manager of a $20 million portfolio of domestic stocks with a beta of 1.10 would like to diversify internationally for six months. He would like to sell $5 million of domestic stock and purchase $5 million of foreign stock. He learns that he can do this using a futures contract on a foreign stock index. The index is denominated in dollars, thereby eliminating any currency risk. He would like the beta of the new foreign asset class to be 1.05. The domestic stock index futures contract is priced at $250,000 and can be assumed to have a beta of 1.0. The foreign stock index futures contract is priced at $150,000 and can also be assumed to have a beta of 1.0.

1. Determine the number of contracts he would need to buy or sell domestic stock index futures. (You must say buy or sell.)

2. Determine the number of contracts he would need to buy or sell foreign stock index futures contract. (You must say buy or sell.)

3. Determine the value of the portfolio if the domestic stock increases by 2 percent, the domestic stock futures contract increases by 1.8 percent, the foreign stock increases by 1.2 percent, and the foreign stock futures contract increases by 1.4 percent.

4. What happen to the portfolio value if the manager had not diversified internationally?

5. Compare the values in c. and d., does the manager gain or lose by diversification and by how much in dollars?

6. Describe, in general term, how the manager can achieve the same goal using equity swap? (There is not need for any calculations.)