You have been assigned to implement a three-month hedge for a stock mutual fund

Question

You have been assigned to implement a three-month hedge for a stock mutual fund portfolio that primarily invests in medium-sized companies. The mutual fund has a beta of 1.4 measured relative to the S&P Midcap 400, and the net asset value of the fund is $180 million

a. Should you be long or short in the Midcap 400 futures contracts?

Long or Short?

Assuming the Midcap 400 Index is at 647 and its futures contract size is 500 times the index, determine the appropriate number of contracts to use in designing your cross-hedge strategy.

You have been assigned to implement a three-month hedge for a stock mutual fund portfolio that primarily invests in medium-sized companies. The mutual fund has a beta of 1.4 measured relative to the S&P Midcap 400, and the net asset value of the fund is $180 million

Explanation / Answer

(a) Short in midcap future contract because beta of the portfolio is 1.4 if a beta is less than 1.0 indicates that the investment will be less volatile than the market, correspondingly, a beta of more than 1.0 indicates that the investment's price will be more volatile than the market. since investment is more volatile so i will suggest for short term investment for midcap future contract.

(b)Price of future contract :- 500 *647=323500

Value of portfolio:- 180,000,000

Beta of portfolio:-1.4

Hedge ratio= value of hedge portfolio/price of future contract*beta cofficient
= (180,000,000/323500)*1.4
   =   778.9 or 779 contracts   

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