The New Horizon Pension Fund decides to hedge its $40 million stock portfolio on June 1. The portfolio has a beta of 1.10. It will use Nasdaq futures contracts selling at 1,571 to hedge. These contracts have a multiplier of 100.
a. With the appropriate beta adjustment factor and rounding the final answer to the nearest whole number, how many contracts should be sold?
b. Assuming that by September 1 the market has gone down by 20 percent and the stock portfolio moves in accordance with its beta, what will be the total dollar decline in the portfolio?
c. Assume the Nasdaq Index futures contracts decline by 20 percent from 1,571. What will be the total dollar gain on the futures contracts? In the process, compare the sale price of 1,571 with the current value, multiply by 100, and then multiply this value by the number of contracts. How does the total dollar gain on the futures contracts compare with the portfolio loss in part b?
d. Now assume that because of changing basis, the stock index futures contract does not move parallel to the market. Although the market goes down by 20 percent, the stock index futures decline by only 15 percent. What will be the gain on the futures contracts? How does this compare with the loss in portfolio value in part b?