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MNM Insurance anticipates that its losses will increase in the following year and as the risk manager you would want to hedge against this risk. Currently the index stands at a loss level of 70%. This amounts to an index level of 0.3 or R300 000 per contract. If the loss ratio declines as anticipated to a level of 75%, it will equate to a level of 0.25 which amount to R250 000 per contract. Losses of R3 Billion are expected for the 10 companies using the pool. 75% of these losses will be reported at the end of the quarter. Total premiums for the companies is R40 Billion. Assume that MNM Insurance's earned premium is R200 000.
The best way a hedge for MNM Insurance using a futures contract in light of the information supplied above is to go short on a futures contract meaning you sell short the index (sell an index that you do not have at hand) at R300 000.
True or False?
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