clearlycanadian

A manager has a 70/30 stock and bond portfolio. To synthetically create a portfolio that is 60 percent stock and 40 percent bonds, the manager should:

A) go long the bond futures and short the stock index futures.

B) go long both bond futures and stock index futures.

C) short the bond futures and go long the stock index futures.

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This move will accomplish the goal by reducing the exposure to equity and increasing the exposure to bonds.

clearlycanadian

A manager has a $100 million portfolio that consists of 50% stock and 50% bonds. The beta of the stock position is 1. The modified duration of the bond position is 5. The manager wishes to achieve an effective mix of 60% stock and 40% bonds. The price and beta of the stock index futures contracts are $277,000 and 1.1 respectively. (The futures price includes the effect of the index multiplier.) The price, modified duration, and yield beta of the futures contracts are $98,000, 6, and 1 respectively. What is the appropriate strategy?

A) Go long 53 bond futures and go long 40 stock index futures.

B) Short 40 bond futures and go long 106 stock index futures.

C) Short 85 bond futures and go long 33 stock index futures.

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Since the manager wishes to increase the equity position and decrease the bond position by $10 million (10% of $100 million), the correct strategy is to take a short position in the bond futures and a long position in the stock index futures:

number of bond futures = -85.03 = [(0 − 5) / 6]($10,000,000 / $98,000)
number of stock futures = 32.82 = [(1 − 0) / 1.1]($10,000,000 / $277,000)

clearlycanadian

An S&P500 index manager knows that he will have $60,000,000 in funds available in three months. He is very bullish on the stock market and would like to hedge the cash inflow using S&P 500 futures contracts. The S&P 500 futures contract stands at 1100.00 and one contract is worth 250 times the index. Which of the following is the most accurate hedge for this portfolio?

A) Sell 218 contracts.

B) Buy 284 contracts.

C) Buy 218 contracts.

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In order to be hedged against stock price increases, S&P 500 futures contracts have to be purchased. The quantity of contracts to buy is computed as follows:
# contracts = (beta)(Portfolio value) ÷ (futures price)(contract multiplier)
                 = (1)(60,000,000) ÷ (1100)(250) @ 218.18 = 218 contracts

clearlycanadian

Redden Capital Management manages an intermediate, high-quality bond portfolio with a value of $12 million dollars. The modified duration of the portfolio is 4.4 years with a yield beta of 1.0. Scott Stuart, the manager of the portfolio is concerned about rising interest rates over the next few months and wants to make a tactical adjustment and cut the duration of the portfolio in half. Stuart asks Amy Swemba, a junior portfolio manager with Redden, to accomplish this task. Swemba is aware that a Treasury bond futures contract exists with a value of $102,000, with a modified duration of 8.2 years. Swemba replies to Stuart’s comments with the following statements:

Statement 1:	The fastest and most cost-effective way to reduce the duration of the portfolio by half would be to sell $6 million dollars worth of the actual bonds in the portfolio.
Statement 2:	The portfolio’s duration could also be adjusted by selling 40 of the Treasury bond futures contracts.

After listening to Swemba’s statements, Stuart should:

A) disagree with Statement 1, but agree with Statement 2.

B) agree with Statement 1, but disagree with Statement 2.

C) disagree with both Statement 1 and Statement 2.

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NOTE – on the exam, it is very likely for material on tactical asset allocation to be tested in conjunction with material from derivatives as tactical asset allocation can be accomplished by selling assets, or with a derivative overlay. Stuart should disagree with both of Swemba’s statements. Although Stuart’s goal of reducing the duration could be accomplished by selling bonds in the portfolio, doing so would likely incur significant transaction costs. Also, since the duration of each bond in the portfolio is likely different, specific bonds would have to be selected in order to accomplish Stuart’s goal, making the process more difficult. A derivative overlay, accomplished by using futures contracts, would be much easier and cost effective. Swemba is also incorrect with respect to the number of futures contracts that would need to be sold. The correct number of futures contracts to be sold is: (1.0)[(2.2 – 4.4) / 8.2]($12,000,000 / $102,000) = -31.56 ≈ -32 futures contracts. The minus sign means that 32 contracts should be sold to achieve the desired duration in the portfolio.

clearlycanadian

The performance of a synthetically reallocated portfolio, e.g., a synthetic adjustment from stocks to bonds, would not exactly match the target position for all of the following reasons EXCEPT:

A) the risk free rate is not zero.

B) rounding of the number of contracts used.

C) duration is not constant.

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The risk free rate does not enter into the formulas for determining the strategy for synthetically adjusting a stock/bond portfolio. Although the risk free rate may play a role in some futures strategies to synthetically adjust a portfolio, the effectiveness of the strategy would not depend upon its value.

clearlycanadian

A manager wishes to make a synthetic adjustment of a mid-cap stock portfolio. The goal is to increase the beta of the portfolio by 0.5. The beta of the futures contract the manager will use is one. If the value of the portfolio is 10 times the futures price, then the futures contract position needed is a:

A) long position in 20 contracts.

B) long position in 5 contracts.

C) short position in 5 contracts.

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We should recall our formula for altering beta,

number of contracts = ({target beta − Bportfolio } × V) / (Bfutures × futures price)

the provided information gives:

number of contracts = 5 = 0.5 × 10 × (futures price) / (1 × futures price).

clearlycanadian

A manager of $30 million in mid-cap equities would like to move half of the position to an exposure resembling small-cap equities. The beta of the mid-cap position is 1.0, and the average beta of small-cap stocks is 1.6. The betas of the corresponding mid and small-cap futures contracts are 1.05 and 1.5 respectively. The mid and small-cap futures prices are $260,000 and $222,222 respectively. What is the appropriate strategy?

A) Short 55 mid-cap futures and go long 72 small-cap futures.

B) Short 17 mid-cap futures and go long 17 small-cap futures.

C) Short 17 small-cap futures and go long 17 mid-cap futures.

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We should recall our formula for altering beta,

number of contracts = ({target beta − Bportfolio } × V) / (Bfutures × futures price)

In this case, for the first step where we convert the mid-cap position to cash, V=$15 million, and the target beta is 0. The current beta is 1.0, and the futures beta is 1.05:

-54.95 = (0 − 1) × ($15,000,000) / (1.05 × $260,000)

The manager should short 55 of the futures on the mid-cap index. Then the manager should take a long position in the following number of contracts on the small-cap index:

72.00 = (1.6 − 0) × ($15,000,000) / (1.5 × $222,222)

Thus, the manager should take a long position in 72 of the contracts on the small-cap index.

clearlycanadian

The practice of taking long positions in futures contracts to create an exposure that converts a yet-to be received cash position into a synthetic equity or bond position is:

A) called leveraging down.

B) illegal.

C) called pre-investing.

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This is the definition of pre-investing using futures contracts, and it is not illegal.

clearlycanadian

A portfolio manager knows that a $10 million inflow of cash will be received in a month. The portfolio under management is 70% invested in stock with an average beta of 0.8 and 30% invested in bonds with a duration of 5. The most appropriate stock index futures contract has a price of $233,450 and a beta of 1.1. The most appropriate bond index futures has a duration of 6 and a price of $99,500. How can the manager pre-invest the $10 million in the appropriate proportions? Take a:

A) short position in 25 of the bond futures and 22 of the stock futures.

B) long position in 22 of the stock futures and 25 of the bond futures.

C) long position in 25 of the stock futures and 28 of the bond futures.

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The goal is to create a $7 million equity position with a beta of 0.8 and a $3 million bond position with a duration of 5:

number of stock futures = 21.8 = (0.8 − 0) × ($7,000,000) / (1.1 × $233,450)
number of bond futures = 25.13 = (5 − 0) × ($3,000,000) / (6 × $99,500)

The manager should take a long position in 22 of the stock index futures and 25 of the bond index futures.

clearlycanadian

A portfolio manager has a net long position in both stocks and bonds and no cash. When pre-investing a future cash inflow, to replicate the existing portfolio, using bond and stock futures, which of the following statements is most accurate? The manager will:

A) go long the stock futures but short the bond futures.

B) have to choose a single futures contract and net the bond and stock position.

C) go long both stock and bond futures.

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Since the original portfolio is long in both stocks and bonds, the manager will go long both stock and bond futures contracts.