You are the manager of a balanced portfolio of bonds and stocks. Assume the securities market values are effective at the close of trading April 10). The markets for both bonds and stocks has been volatile and you want to use derivatives to adapt to the markets over the April 10-24 period.
For the two week period, you are to create a long or short hedge for the bonds in your portfolio and a long or short hedge for the stocks in your portfolio (two hedges). You can use futures contracts, options on futures, or CBOE options to construct your hedges. Note this is an individual project.
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First half part :
No later than April 13, you are to submit to me a one page summary of the ollowing.
1. A brief assessment of your market expectations for the 2 week period.
2. A specific description of the hedges used in your portfolio stock and bond positions including number of contracts and contract prices. (Prices will be available by 4:00P Friday and can be accessed all weekend from the CMEGroup and CBOE websites.) The hedges must be consistent with your market expectations.
The summary must be submitted to the Dropbox Course Project Hedge folder no later than Monday, April 13. (The Hedge folder will be open only through April 13 so any submissions late will assessed a 10 point/day discount). You will hold your hedge through April 24 at which time you are to close out your derivatives positions and compute your portfolio gains and/or losses for both your stock and bond positions.
For this assignment, I have already finished the first half part. Following is my portfolio:
Bond Hedge
If the interest rate drops as expected, the value of the bonds in the portfolio will decrease. Since there is a risk of asset price falling, I will apply short hedge. I will short the US Treasury Bond Futures. The price of JUN 15 US Treasury Bond Future on April 10th is $163 16/32. By plugging the bond portfolio value, future value, duration and modified duration of each bond, I obtain the price sensitivity hedge ratio of -1.02.
To hedge the bond portfolio, I will short one contract JUN 15 US Treasury Bond Future with the price of $163 16/32.
Stock Hedge
Based on the weight and beta of each stock in the portfolio, the portfolio beta is 1.01. To protect the portfolio against the likely decreasing market, I will long the stock portfolio and short the standard S&P 500 futures contract. The price of JUN 15 S&P 500 FUTURE on April 10th is $2,095.50. The market value of the stock portfolio on April 10th is $670,630. By plugging the data in to the formula of stock index futures hedge ratio, I obtain the hedge ratio of -1.28.
To hedge the stock portfolio, I will long the stock portfolio at spot price ($670,630) and short one contract JUN 15 S&P 500 FUTURE with the price of $2095.50.
Over
I am not sure if my hedge strategy is legitimate. Please base on my strategy to finish the second part
Highlight contents are second part:
No later than April 28 you are to submit one-two page summary of your hedges in hardcopy. Your performance summary should include the hedged and unhedged portfolio (stocks, bonds, total). You should also describe the strengths or weaknesses in your strategy. Electronic submissions are not accepted.