Reference no: EM132983986

Assume you are an American investor investing in British stocks. The market value of the portfolio is £20 million, with a ? of 1.5 (relative to the FTSE index). The spot value of the FTSE index is 4,000. The dividend yield, euro interest rates, and pound interest rates are all equal to 4%.

Problem (a) You fear a drop in the British stock market (but not in the British pound). The size of FTSE stock index contracts is 10 pounds times the FTSE index. Calculate the futures price of the index. (Show your calculations)

Problem (b) How many contracts should you buy or sell to hedge the British stock market risk? Would you take a long or short hedged position, explain? (Show your calculations)

Problem (c) You believe that the capital asset pricing model (CAPM) applies to British stocks. The expected stock market return is 10%. What is the expected return on this portfolio before and after hedging? (Show your calculations)

Problem (d) You now fear a depreciation of the British pound relative to the USD. Will the strategies above protect you against this depreciation?