Question

a company has a $20 million portfolio with a beta of 1.2. it would like to use futures contracts on a stock index to hedge its risk. the index futures is currently standing at 1080, and each contract is for delivery of $250 times the index. (a) what is the hedging strategy that minimizes risk? (b) what should the company do if it wants to reduce the beta of the portfolio to 0.6?

Answer 1

To minimize risk, the company should take a short position in index futures. To reduce the beta of the portfolio to 0.6, the company should adjust the weight of the stock index futures in their portfolio.

a) To minimize risk, the company should take a short position in index futures.

This means that they should sell futures contracts on the stock index.

By taking a short position, the company will profit if the stock index decreases in value, offsetting any losses in their portfolio.

b) To reduce the beta of the portfolio to 0.6, the company should adjust the weight of the stock index futures in their portfolio.

They should calculate the number of futures contracts needed to achieve the desired beta of 0.6 and adjust accordingly.

By buying or selling futures contracts, the company can increase or decrease the beta of their portfolio.