“MINIMIZING CASH DRAG WITH S&P 500 INDEX TOOLS,” JOANNE M. HILL...

2. “Minimizing Cash Drag with S&P 500 Index Tools,” Joanne M. Hill and Rebecca Cheong,

Equity Derivatives Research (Goldman, Sachs, June 11, 1996, revised)

Purpose:

To test the candidate’s knowledge of futures and alternative instruments by altering a portfolio’s

expected return.

LOS: The candidate should be able to

“Stock Index Futures: Refinements” (Session 17)

• compute the correct number of index futures contracts required to partially or completely hedge

an equity portfolio;

• construct a strategy to decrease/increase the beta of a portfolio, including calculating the number

of futures contracts;

• create a synthetic T-bill or synthetic equity position using the appropriate futures contracts.

“Minimizing Cash Drag with S&P 500 Index Tools” (Session 17)

• compare and contrast the two primary tools used in cash management of equity index portfolios;

• design and evaluate a cash management strategy using futures;

• calculate and appraise returns from a cash management strategy using index futures or S&P 500

Depository Receipts (SPDRs) with returns from leaving a portion of the portfolio in cash;

• compare and contrast the cost of excess cash versus an appropriate cash management strategy

using futures or SPDRs;

• illustrate similar cash management strategies using alternative index instruments.

Guideline Answer

A. The number of futures contracts required is:

N = (value of the portfolio/value of the index futures) × beta of the portfolio

= [$15,000,000 / (1,000 × 250)] × 0.88

= [$15,000,000 / 250,000] × 0.88

= 60 × 0.88

= 52.8 contracts

Selling (going short) 52 or 53 contracts will hedge $15,000,000 of equity exposure.

B. Alternative methods that replicate the futures strategy in Part A include: