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Calculate the insurance premium

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A well diversified stock portfolio worth $30,000,000 has a beta of 1.4. The dividend yield of the portfolio is 2.1% per annum with simple compounding. The S&P 500 index is currently trading at 1350 and the dividend yield of the index is 1.6% per annum with simple compounding. The riskOfree interest rate is 4.5% per annum with continuous compounding.

(a) Describe the (portfolio insurance) strategy that would insure against 20% loss in the portfolio over the next four months.

(b) Calculate the insurance premium. Assume that the volatility of the index is 15% per annum and the dividend yields and the riskOfree interest rate when expressed as simple rates are approximately the same as the continuously compounded rates.

(c) Calculate the gain or loss of the strategy, if the level of the market in four months is 1100. Discuss the outcome of the insurance strategy.

(d) Calculate the gain or loss of the strategy, if the level of the market in four months is 1500. Discuss the outcome of the insurance strategy.

Reference no: EM13208774

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