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FRM Practice Questions (PQs; for PAID customers)
[P1|P2] Hull's Options, Futures (OFOD 8, 9 ,10th)
Hull.03.18 Discussion in '[P1|P2] Hull's Options, Futures (OFOD 8, 9 ,10th)' started by Suzanne Evans, Oct 4, 2012.
Question: On July 1, an investor holds 50,000 shares of a certain stock. The market price is $30 per share. The investor is interested in hedging against movements in the market over the next month and decides to use the September Mini S&P 500 futures contract. The index is currently 1,500 and one contract is for delivery of $50 times the index. The beta of the stock is 1.3. What strategy should the investor follow? Under what circumstances will it be profitable?
Suzanne Evans
Answer:
Administrator
A short position in contracts is required. It will be profitable if the stock outperforms the market in the sense that its return is greater than that predicted by the capital asset pricing model. Suzanne Evans, Oct 4, 2012
#1
Hi David, "It will be profitable if the stock outperforms the market in the sense that its return is greater than that predicted by the capital asset pricing model." If stock outperforms, future spot price is higher, so short position will be a loss, how it is profitable as mentioned above?
Tril
Regards, Trilo
Member
Tril, Jan 17, 2016
#2
Tril said:
If stock outperforms, future spot price is higher, so short position will be a loss, how it is profitable as mentioned above?
Hi Tril, But the short position is in S&P 500 futures, while the long position is in stock of this company. So if the stock outperforms the S&P 500 (i.e. the market) the investor will make a profit.
ami44
Active Member
ami44, Jan 17, 2016
#3
Thanks Ami44, True for long position in stock, but are we assuming that S&P 500 under performing to stock, so future price wont increase that much,so short position wont incur that much loss compared to profit made in long stock. Regards, Trilochan
Tril
Member
Tril, Jan 17, 2016
#4
Tril, sorry, I'm not exactly sure what your question is, but let me try to clarify anyway: The stock has a beta of 1.3, that means we expect the profit to be 1.3 times the profit of the market portfolio. We assume the S&P 500 is a good proxy for the market portfolio. If the return from the stock is exactly 1.3 times the return from the S&P futures, then the long and the short position cancel each other perfectly. In case of a higher return, there will be a profit.
ami44
ami44, Jan 17, 2016
Active Member
#5
Winner x 1
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FRM Practice Questions (PQs; for PAID customers)
[P1|P2] Hull's Options, Futures (OFOD 8, 9 ,10th)
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