Response to the following problem:
Not long ago, Vanessa Wong sold the company she founded for several million dollars (after taxes); she took some of that money and put it into the sharemarket. Today, Vanessa's portfolio of blue-chip shares is worth $2.3 million. Vanessa wants to keep her portfolio intact, but she is concerned about a developing weakness in the market for blue chips. She decides, therefore, to hedge her position with six-month futures contracts on the ASX 200, which are currently trading at 4724.
a. Given that Vanessa wants to cover the full $2.3 million in her portfolio, describe how she would go about setting up this hedge.
b. If each contract required a margin deposit of $7000, how much money would she need to set up this hedge?
c. Assume that over the next six months share prices do fall, and the value of Vanessa's portfolio drops to $2.1 million. If the ASX 200 Index is at 4475, how much will she make (or lose) on the futures hedge? Is it enough to offset the loss in her portfolio? That is, what is her net profit or loss on the hedge?
d. Will she now get her margin deposit back, or is that a ‘sunk cost'-gone forever?