Chapter 21, Problem 1CP

a.

Summary Introduction

To analyze: The accuracy of statement given by the Board’s consultant “The $100 million equity portfolio can be fully protected on the downside by selling (shorting) 4000 futures contracts.”

Introduction:

Hedge Ratio: Hedge ratio is also called as ‘delta’. This ratio is used to calculate the number of hedges required to safeguard or protect against the risk of portfolio’s loss while dealing with commodity derivatives. It can be obtained when the option value is divided by the change in stock price. When the ratio is between 1 to 100%, it means that it is a fully hedged position and when the ratio is 0, it means that it not hedged.

b.

Summary Introduction

To analyze: The accuracy of statement given by the Board’s consultant “The cost of this protection is that the portfolios expected rate of return will be zero percent.”

Introduction:

Expected rate of return: When an investment is made, the investor expects or anticipates some return. The rate at which this anticipated or expected returns are earned is called expected rate of return. It is also called as anticipated rate of return.