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The tasks is: Identify the problem in the scenario, quantify the financial exposure Conduct a fundamental and technical analysis of the asset class Recommend the

Thetasks is:

  • Identify the problem in the scenario, quantify the financial exposure
  • Conduct a fundamental and technical analysis of the asset class
  • Recommend the position or positions that can be taken in the derivativemarket,explain the rationale and quantify the expected reduction in the exposure.
  • Reassess your position after threeweeks withthe movements of the derivative market and quantify the exposure, recommend changes if applicable.
  • Provide a cash flow summary and conclude the hedging exercise carried out.

Scenario

You are a fund manager with a portfolio worth $50million that has a beta of 0.87 against the S&P500. Your employer is concern about the performance of the market over the next two months and plans to use 3-months futures contract on the S&P500 to hedge the risk.

S&P INDEX: 2989.69

S&P FUTURE INDEX: 2991.40

CONTRACT SIZE: 250

HOLDING TIME: 2 MONTHS

Risk-free rate: 1.59%

Risk-free rate (2 months): 0.265%

Dividend yield: 3%

Dividend yield (2 months): 0.5%

Number of Contracts: 58

By observing the current 3 months US risk free interest rate, contract size of the 3-months futures index (refer to the contract size at the CME website), design a position to hedge the exposure of the market for over the next two month (Assume the dividend yield on the index is 3% per annum). Re-assess the exposure after 3 weeks. Establish the outcome and cash flow position.

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