USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
As a portfolio manager, you are responsible for a $150 million portfolio, 90 percent of which is invested in equities, with a portfolio beta of 1.25. You are utilizing the S&P 500 as your passive benchmark. Currently the S&P 500 is valued at 1202. The value of the S&P 500 futures contract is equal to $250 times the value of the index. The beta of the futures contract is 1.0.
-Refer to Exhibit 15.11. If you anticipate a cash inflow of $2 million next week, how many futures contracts should you buy or sell in order to mitigate the effect of this inflow on the portfolio's performance (rounded to the nearest integer)?
A) sell six contracts
B) buy six contracts
C) sell eight contracts
D) buy eight contracts
E) buy seven contracts

Question

Quizplus · Accepted Answer

To mitigate the effect of the cash inflow on the portfolio's performance, you need to calculate the number of futures contracts to buy. First, calculate the equity position after the cash inflow: $150 million * 90% = $135 million (current equity position) + $2 million = $137 million (new equity position). The difference that needs to be hedged is $2 million. The value of one S&P 500 futures contract is $250 * 1202 = $300,500. The number of contracts needed = ($2 million / $300,500) = 6.66, rounded to the nearest integer is 6 contracts. Therefore, you should buy six contracts to maintain the portfolio's performance.