Question: A non-profit foundation has a portfolio heavily weighted in stocks valued at $5,000,000. The foundation's director is concerned about potential short-term (three-month) declines in the foundation's portfolio that may occur due to a variety of contemporary issues, e.gr political changes. The portfolio is constructed such that it is has an effective beta of1 40 (compared to the S&P 500). The foundation's director would like to reduce portfolio's short term risk entirely such that they portfolio will neither nor lose money over the next three months. The future's exchange trades a mini S&P 500 index that has a size equal to $50 per index point. The S&P 500 is currently trading at 2, 104 in the spot market and the futures (three months out) are trading at 2.095.
(a) What should the foundation's director do in the futures market in order to temporarily hedge their position (Number of contracts and position) Explain. Over time the director's concerns were realized as the S&P 500 falls points. The S&P 500 (spot market) is now trading at 1, 999. Futures are trading at 1, 997.
(b) In percentage terms how much did the market fall (as measured by the spot S&P 500 index)?
(c) In percentage terms how much did the foundation's portfolio fall (without futures hedging) assuming the portfolio's reported beta is accurate?
(d) lf the director had not chosen to adjust the fund's beta what would the foundation's fund be worth now?
(e) What is the portfolio worth given that the director chose to hedge?