You manage a $19.5 million portfolio, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio tempo-rarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to temporarily hedge your equity holdings with E-mini S&P 500 index futures contracts.a. Should you be long or short the contracts? Why?b. If your equity holdings are invested in a market-index fund, into how many contracts should you enter? The S&P 500 index is now at 1,950 and the contract multiplier is $50.c. How does your answer to part (b) change if the beta of your portfolio is .6?

Question
Asked Mar 10, 2020
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You manage a $19.5 million portfolio, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio tempo-
rarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to temporarily hedge your equity holdings with E-mini S&P 500 index futures contracts.
a. Should you be long or short the contracts? Why?
b. If your equity holdings are invested in a market-index fund, into how many contracts should you enter? The S&P 500 index is now at 1,950 and the contract multiplier is $50.
c. How does your answer to part (b) change if the beta of your portfolio is .6?

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Expert Answer

Step 1

( a.) The manager should short the contracts.

Future contract on the stock or any financial index is a short index. There are a number of multiples for the computation of future contract prices for a specific index. Identifying the index tends to be trending lower and selling the index ‘s mini index future is the main purpose of short index future trade.

The cash index will fall with the fall in the market. Shorting the index future is helpful in protecting the price of downside stock fall. Future contracts can be closed down at a low price when there is a fall in the future index and can earn a profit. Future contract profit is helpful in setting off the loss to the equity portfolio.

Step 2

b.

The calculation of the contract size as follows:

Finance homework question answer, step 2, image 1

The calculation of the number of the contract required if the beta is 1 as follows:

Finance homework question answer, step 2, image 2

...

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