Reference no: EM133076045

What does hedging mean? Assume you have a 6 million dollar well diversified portfolio. The La Salle Comprehensive Stock Index (LCSI) stands at 1500. Options on the Index sell at multiples of 100 (each contract is worth $150,000). The at-the-money (the exercise price equals the Index value) three month Call option is currently priced at 12 (meaning $1200) and the at-the-money three month Put option is currently priced at 9 ($900). Because of events pertaining to the President's behavior issues, you are afraid that stocks may fall in the near term (the next three months). You do not wish to liquidate your portfolio. Employ a Call or a Put option strategy to hedge your position. Defend your strategy. Now assume that over the next three months, both the market and your portfolio decrease by one percent. ANALYZE what happened to your overall position. Looking back, was there a better hedging strategy? Did you make the correct decision?

Consider a two-asset world. Asset 1 has an expected return of 10 percent and a standard deviation of 20 percent. Asset 2 has an expected return of 15 percent and a standard deviation of 38 percent. The correlation coefficient between these two assets is 1.00.

Carefully draw the efficient frontier for this two-asset world. SHOW how a portfolio manager would maximize a client's welfare in this world. Explain your answer.