Commodities and Financial Futures
Not long ago, Vanessa Woods sold her company for several million dollars (after taxes). She took some of that money and put it into the stock market. Today, Vanessa's portfolio of bluechip stocks is worth 3.8 million. Vanessa wants to keep her portfolio intact, but she's concerned about a developing weakness in the market for blue chips. She decides, therefore, to hedge her position with six month futures contracts on the Dow Jones Industrial Average, which are currently trading at 11,960.
a. Why would she choose to hedge her portfolio with the DIJA rather than the S&P500?
b. Given that Vanessa wants to cover the full 3.8 million in her portfolio, describe how she would go about setting up this hedge.
c. Assume that over the next six months, stock prices do fall, and the value of Vanessa's portfolio drops to 3.3 million, if DIJA futures contracts are trading at 10400, how much will she make or lose on the futures hedge? is it enough to oddest the loss in her portfolio? That is, what is her net profit or loss on the hedge?
e. Will she now get her margin deposit back, or is that a sunk cost-gone forever?
A) The Dow Jones is comprised of large cap stocks, while the S&P500 has large and medium cap stocks. Since Vanessa has only Blue Chips, which are the large cap stocks, the DJ futures would be a better hedge than the S&P500 futures.
B) Vanessa would short DJ futures that ...
A discussion on hedging strategies on a portfolio including the use of futures.