1. Cross Hedging R. Srinivasan

2. Question 1 It is 20 th June, and a Pension fund wishes to hedge Rs. 1 mn stock. The hedge period is of 5 months. Portfolio  = 1.5. The dividend yield on the equity portfolio = 4% p.a. Choose to hedge with December futures contract with t = ½. The current level of Index is at 6400 spot and the futures contracts trade at Rs. 10 per index point. How many contracts you will short to hedge your position. Let r f = 10%.

3. Solution

4. Question 3 Let NIFTY be at 1000 points, value of your portfolio be 5.05 mn, r f = 4%, dividend yield on the Index = 1%, and  of Portfolio = 1.5. Assume that the futures contract on the index with 4 months maturity is used over the next 3 months. Let F 1 = 1010. What is the expected return on the portfolio, if NIFTY comes out to be 900 in Dec and the futures price in Dec works out to be F 2 = 902. Show the expected value of hedger’s position including gain on the hedge.

5. Solution E(r m ) = (1000 – 900) / 1000 = – 10% E(r m ) = – 10% + 0.25% = – 9.75% E(r p ) = r f + 1.5 x (-9.75 – 1) = – 15.125% Therefore, the expected portfolio value = 5050000 ( 1 – 0.15125) = 4286188 Gain on hedge = 30 x (1010 – 902) x 250 = 810000 Hedger’s total gain = = 4286188 + 810000 = 5096188 Hedger’s return = (5096188 – 5050000) / 5050000 = 46188 / 5050000 = 0.91%  1% = r f The hedger gains r f rate due to hedging.