42 RELATE TO UNITED GLOBAL GROUP. UNITED GLOBAL GROUP (UG...

Questions 37-42 relate to United Global Group.

United Global Group (UGG) is a major property and casualty insurance company. UGG has a

total investment portfolio of $25 billion. The portfolio is divided into $22 billion in bonds and $3

billion in equities. UGG's equity strategy employs enhanced indexing with the S&P 500 Index as

the benchmark. UGG adjusts its equity portfolio by employing a simple 200-day moving average

technical indicator. When stocks increase in value above their 200-day moving average, this is a

bullish indicator. In contrast, when they fall below their 200-day moving average, this is a bearish

indicator. UGG management uses this indicator to move in and out of equities. Rather than

actually selling their equities, UGG uses futures to create a synthetic cash position to execute

any bearish trigger. Relevant data is shown in Figure 1.

Figure 1: Selected Data

S&P 500 Index futures contract 1058

S&P 500 Index dividend yield 1.60%

Time to expiration 5 months

Risk free rate (annual) 3.00%

UGG equity portfolio beta 1.00

S&P 500 Index futures contract beta 1.00

UGG bond portfolio modified duration 5.90

Treasury bond futures contract price $150,000

Treasury bond futures modified duration 5.10

Cash equivalents modified duration 0.20

S&P 500 Index futures contract multiplier $250

UGG's management applied its technical indicator to the Japanese market and discovered that

prices have crossed above their 200-day moving average. Based on this bullish signal,

management allocated half of UGG's equity portfolio, 162,225,000,000 yen, to the Japanese

market. Relevant data are shown in Figure 2.

Figure 2: Selected Data

Nikkei 225 index futures contract (USD) 10,337

Nikkei 225 index dividend yield 1.00%

Time to expiration 6 months

Japanese risk-free rate (annual) 2.00%

Multiplier $5.00

Nikkei 225 index futures contract beta 1.00

UGG's Japanese portfolio beta 0.90

Exchange rate 108.15 yen to $1

...

Assuming the initial $3 billion position in U.S. equities and the information in Figure 1, if UGG

wishes to convert the entire position to synthetic cash, the most appropriate strategy would be to

sell approximately:

A) 11,108 S&P futures contracts.

B) 11,342 S&P futures contracts.

C) 11,483 S&P futures contracts.

Question #38 of 60

Assume the S&P 500 Index is at 1,125 when these futures contracts expire. The payoff on the

futures position would be a loss:

A) of less than $1 million.

B) between $1 million and $100 million.

C) greater than $100 million.

Question #39 of 60

UGG management intends to adjust its $22 billion in bonds and $3 billion in equities to 75%

bonds and 25% stocks. Using the information provided in Figure 1, the strategy to adjust to the

new bond and stock allocation is to sell bond futures contracts and buy approximately:

A) 12,290 equity futures contracts.

B) 13,387 equity futures contracts.

C) 15,199 equity futures contracts.

Question #40 of 60

UGG has now purchased the Japanese equities and would like to fully hedge against a possible

decline in the Japanese market. Using the data in Figure 2, the number of (short) contracts

needed to hedge the yen-denominated portion of the equity portfolio is closest to:

A) 24,000 and 25,000 contracts.

B) 25,000 and 26,000 contracts.

C) 26,000 and 27,000 contracts.

Question #41 of 60

Which of the following statements is most correct?

A) UGG can use country beta to adjust their exposure to equities.

B) UGG can hedge their foreign currency equity risk by buying the foreign currency forward.

C) UGG can replicate a long foreign stock position by buying equity futures and a risk-free bond.

Question #42 of 60

UGG is exposed to the U.S. bond market and both the U.S. and Japanese equity markets. Given

these exposures, which of the following statements is most correct?

A) UGG is likely to use a mixture of corporate and Treasury bond futures to hedge their U.S. bond

portfolio.

B) UGG is likely to manage exchange rate risk using forward contracts on the yen/USD exchange

rate for liquidity reasons.

C) UGG can lock in the Japanese risk-free rate by using futures to hedge the equity portfolio and

using a forward to hedge yen/USD currency risk.

Question #43 of 60