Chapter 20, Problem 16PS

Summary Introduction

(a)

To calculate:

The number of contracts that should be entered, if he holds a $\$6$ million portfolio of waterworks stock, for hedging purpose using the one-month maturity future contacts of S&P $500$ index.

Introduction:

Hedging is referred as the protection from the fluctuations in the price of stocks which can cause losses to the investor on investments. It can be more understood by saying that if we go long in the market then it can involve protection against downside fluctuations and if we go short in position in the market then it can involve protection against upsides fluctuations.

Summary Introduction

(b)

To calculate:

The standard deviation of the monthly return of the hedged portfolio

Introduction:

Standard deviation is a measure to calculate the deviation from the mean which is also called as a measure of dispersion. It helps in analyzing the performance of the fund.

Summary Introduction

(c)

To calculate:

The probability of getting negative return taking an assumption that there is a normal distribution of monthly returns and the risk free rate is $0.5\%$ .

Introduction:

Hedging is referred as the protection from the fluctuations in the price of stocks which can cause losses to the investor on investments. It can be more understood by saying that if we go long in the market then it can involve protection against downside fluctuations and if we go short in position in the market then it can involve protection against upsides fluctuations.