14. The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month. Bodie, Z., Kane, A. & Marcus, A.J. (2013). Investments (10th ed.). © McGraw-Hill Education Page 1 of 5 Beta R-square Standard Deviation of Residuals .75 .65 .06 (i.e., 6% monthly) a. If he holds a $2 million portfolio of Waterworks stock, and wishes to hedge market exposure for the next month using 1-month maturity S&P 500 futures contracts, how many contracts should he enter? Should he buy or sell contracts? The S&P 500 currently is at 1,000 and the contract multiplier is $250. b. What is the standard deviation of the monthly return of the hedged portfolio? c. Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month? Assume the risk-free rate is .5% per month.

14. The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month. Bodie, Z., Kane, A. & Marcus, A.J. (2013). Investments (10th ed.). © McGraw-Hill Education Page 1 of 5 Beta R-square Standard Deviation of Residuals .75 .65 .06 (i.e., 6% monthly) a. If he holds a $2 million portfolio of Waterworks stock, and wishes to hedge market exposure for the next month using 1-month maturity S&P 500 futures contracts, how many contracts should he enter? Should he buy or sell contracts? The S&P 500 currently is at 1,000 and the contract multiplier is $250. b. What is the standard deviation of the monthly return of the hedged portfolio? c. Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month? Assume the risk-free rate is .5% per month.

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter8: Risk And Rates Of Return

Section: Chapter Questions

Problem 18PROB

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