| ASSIGNMENT 2 |
| 1. A Pension Fund manager is expecting a $50 million cash flow 3 months from now which he |
| must invest in the equity market. The market is expected to go up in the short run; thus prices |
| would be higher when funds are available for investment. To protect against this, the manager |
| decides to hedge using Stock Index Futures. The Dow Jones Industrial Average is currently |
| at 9311.19. Yesterday's Settlement Level for the DJIA futures index for settlement in 3 months |
| was 9377. Contract size is $500 X Futures Index. Economists predict an increase of 4.5% in the |
| Dow and in the futures. The average beta of stocks in which the funds would be invested is 0.87. |
| Calculate the following: |
| (a) No. of contracts required for hedging. |
| (b) If forecasts are true, the gain or loss on the hedge. | | | | | | | | 2 |
| 2. Use one sentence each to describe how you would hedge in the | | | | | | | | 2 |
| following situations: |
| (a) You own a $1 million stock portfolio |
| (b) Your Company will receive 1 million British Pounds in three months |
| ( c) You are a farmer with a corn crop coming up in three months |
| (d) Your Refinery needs to buy crude oil in 3 months |
| 3. A bank manager will get $6 million to invest in 3 months. Interest rates are expected to fall; | | | | | | | | | 1 |
| so when the money arrives he would have to invest at lower rates. He will invest in T-Bills. |
| To protect his position, the manager decides to hedge by using T-bill futures. |
| | | | | T-Bills | | T-Bill Futures |
| | Current Price | | | $983,190 | | $980,750 |
| | Price in 3 months | | | $985,845 | | $983,550 |
| Should the bank manager use a long hedge or a short hedge? |
| Calculate the number of contracts and his gain or loss on the hedge. |
| 4. Describe in detail two different ways you can hedge against foreign exchange risk. | | | | | | | | | 1 |
| Use an example to illustrate. Preferably use the same example for all three strategies. |
Akanksha74
hedging_questions.xlsx
