Determine the effective return on the stock

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Reference no: EM131323562

On November 1, an analyst who has been studying a firm called Computer Sciences believes the company will make a major new announcement before the end of the year. Computer Sciences currently is priced at 27.63 and has a beta of 0.95. The analyst believes the stock can advance about 10 percent if the market does not move.

The analyst thinks the market might decline by as much as 5 percent, leaving the stock with a return of 0.10 þ (0.05)(0.95) ¼ 0.0525. To capture the full 10 percent alpha, the analyst recommends the sale of a particular stock index futures. The March contract currently is priced at 393.

Assume the investor owns 100,000 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 December 31, the stock is sold at 28.88, the futures contract is at 432.30, and the multiplier is 500. Explain your results.

Reference no: EM131323562

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