You manage a portfolio that is currently all invested in equities in companies in five major Canadian industries. The market value involved and beta for each industry are shown in the table below
|
Industry
|
MV
|
Beta
|
|
Oil and Gas
|
$1,000,000
|
1.2
|
|
Technology
|
600,000
|
1.5
|
|
Utilities
|
1,500,000
|
0.8
|
|
Financial
|
800,000
|
1.3
|
|
Pharmaceutical
|
1,300,000
|
1.1
|
You believe that the Canadian equity market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decide to hedge your portfolio with three-month S&P/TSX 60 index futures contracts for one month. Currently, the level of the S&P/TSX 60 index is 678.68, the three-month futures price of the S&P/TSX 60 is 665.60, and one contract is for $200 times the index. The annual simple risk-free rate of return is 1%.
A) How many futures contracts should you use? Long or short?
B) Suppose the return on the S&P/TSX 60 index is -5% in one month, and the S&P/TSX index futures price falls to 620 in one month. Calculate your net gain or loss on your hedged portfolio in part (a).