21. Suppose that the benchmark for an equity portfolio of USD 12 million is the S& 500. Also suppose the current value of the S& 500 is 1,040 and the portfolio beta relative to the S& 500 is 1.4. If the portfolio manager wants to completely hedge the portfolio over the next 3 months using the S& 500 index futures (that has a multiplier of 250), which of the following is the correct hedging strategy?

A. Long 46 contracts

B. Short 46 contracts

C. Long 65 contracts

D. Short 65 contracts

Correct answer is Dfficeffice" />

Since a complete hedge is desired, our target beta is '0'.

No. of Contracts   

    = (target beta ? portfolio beta) X (portfolio value / underlying asset value)

              = (0 ? 1.4) X [12,000,000 / (1,040 X 250)] = ? 64.62

Since the sign is negative, we need to short 65 contracts.

Reference: ffice:smarttags" />Hull, Chapter 3.

Type: Market Risk.