On January 1, an analyst who has been reviewing a firm called Gild Mathematics believes the company will make a big announcement before May 1. Gild Mathematics currently is priced at $22.15 and has a beta of .90. The analyst believes that the stock can advance about 15% if the market does not move. The analyst thinks the market might decline by as much as 10%, leaving the stock with a return of 6% [15% + (-10% *.9)]. To capture the full 15% alpha, the analyst recommends the sale of a stock index futures. The June contract currently is priced at $358. Assume the investor owns 120,000 shares of the stock. Set up a transaction by determining the appropriate number of futures contracts. Then determine the effective return on the stock if, on May 1, the stock is sold at $23.85. The futures contract is at $393 and the multiplier is $550. Describe your results.
a. Is the analyst concerned about a market increase or decrease?
b. On January 1, what is the total stock position worth?
c. On May 1, what is the total stock position worth?
d. How much did the stock portfolio gain or lose in value since January 1 (must state if gain or loss and the amount)?
e. On January 1, how much is one futures contract worth? How many futures contracts are needed (round up)? Do you buy or sell the futures contracts?
f. On May 1, does the firm buy or sell the futures contracts? How much is one futures contract worth?
g. Is there is a gain or loss on the futures contract? If so, how much is the gain or loss on all the contracts combined?
h. What is the net value of the stock on May 1 (stock and futures contracts combined)? What is the effective return on the stock (in %)