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Question - A company has a portfolio of stocks worth £10 million. The beta of the portfolio is 1.40. The company would like to use the FTSE 100 index futures contract to hedge the portfolio's exposure to the market. The index future price is 3,500 and each contract is on £10 times the index.
a) Explain the basic principle of hedging a risk and available hedging strategies using futures.
b) What strategy should the company take if they wish to hedge the portfolio's exposure to the stock market?
c) Why should the company take the hedging strategy stated in your answer to Question b)?
d) How many contracts should the company hold if they wish to completely eliminate the market risk?
e) Suppose that the company has changed its mind and decides to increase the beta of the portfolio from 1.40 to 1.75. What position in the futures contracts should they take and how many contracts are needed?
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