Question

Currently you are holding a portfolio of stocks worth RM2,465,000. You wish to hedge your portfolio. You have the following information:

Portfolio Beta = 0.90
Spot Index Value= 1530 points
Risk Free Rate = 6% per annum
3 month Stock Index Futures Contract = 1,544.20
Expected Dividend Yield = 0%

The multiplier is RM50

(i) Determine the number of SIF contract to fully hedge your portfolio.
(ii) Outline the hedge strategy and show the resulting portfolio value assuming the market falls 20% by futures maturity.

Answer 1

(i)

Since you wish to hedge against a fall in the portfolio value, you should short the index futures.

number of contracts to short = (current portfolio value * portfolio beta) / (multiplier * current value of futures contract)

number of contracts to short = (2,465,000 * 0.90) / (50 * 1,544.20)

number of contracts to short = 28.73

As fractional contracts cannot be traded, this is rounded off to 28

(ii)

Futures price = spot price * e^rt (where r = risk free rate, and t = maturity of contract in years)

Spot value of index in 3 months = current value * (1 - 20%) = 1530 * (1 - 20%) = 1,224

Futures price in 3 months = spot price in 3 months * e^0.06*(3/12) = 1,224 * e^0.06*(3/12) = 1,242.50

Gain on futures contracts = (current futures price - futures price in 3 months) * number of contracts * contract multiplier

Gain on futures contracts = (1,544.20 - 1,242.50) * 28 * 50 = RM422,382.25

Loss on stock portfolio = current value * % fall in market * portfolio beta

Loss on stock portfolio = RM2,465,000 * 20% * 0.9 = RM443,700

Net loss = loss on stock portfolio - gain on futures contracts

Net loss = RM443,700 - RM422,382.25 = RM21,317.75

Net portfolio value (after hedging) = current value - net loss = RM2,465,000 - RM21,317.75 = RM2,443,682.25