short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and re-establishing your equity position. Instead, you decide to hedge your portfolio with three-month S&P/TSX 60 index futures contracts for one month. Currently, the level of the S&P/TSX 60 index is 851.38, the three-month futures price of the S&P/TSX 60 is 856.40, and one contract is for $200 times the index. The annual simple risk-free rate of return is 1%. How many futures contracts should you use?
D & R A1 11 - 2
Question 11. Hedging with Stock Index Futures
You manage a portfolio that is currently all invested in equities in companies in five major Canadian industries. The market value involved and beta for each industry are shown in the table below.
|
Industry |
Market Value |
Beta |
|
Oil and Gas |
$1,100,000 |
1.2 |
|
Technology |
900,000 |
1.5 |
|
Utilities |
1,500,000 |
0.8 |
|
Financial |
1,000,000 |
1.3 |
|
Pharmaceutical |
800,000 |
1.1 |
You believe that the Canadian equity market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and re-establishing your equity position. Instead, you decide to hedge your portfolio with three-month S&P/TSX 60 index futures contracts for one month. Currently, the level of the S&P/TSX 60 index is 851.38, the three-month futures price of the S&P/TSX 60 is 856.40, and one contract is for $200 times the index. The annual simple risk-free rate of return is 1%.
- How many futures contracts should you use?
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