Questions 43 through 48 relate to Risk Management Applications of Derivatives.
Rose Michael Case Scenario
Rose Michael, CFA, is a senior portfolio manager at Platinum Investments, Inc. Selected
data for the funds she manages is shown below in Exhibit 1:
Exhibit 1
Summary of Fund Characteristics
Fund A Fund B Fund C Fund D
60% mid-cap
100% mid-cap
U.S. equities
100% U.S.
100% large-cap
Asset
Treasury bonds
Allocation
40% U.S.
Stock Beta 0.95 1.20 N/A 1.12
Duration n.a. n.a. 5.9 5.9
Michael is training Joseph Owen, a newly hired research assistant, in the strategies used
to adjust clients’ exposures to various markets. She asks Owen to collect current market
data on the futures contracts she uses to employ the asset allocation strategies. Owen
presents Michael with the data in Exhibit 2 and notes that the U.S. risk-free rate is 4
percent while the European risk-free rate is 2 percent.
Exhibit 2
Summary of Futures Contracts Data
U.S.
European
U.S. Treasury
U.S.
U.S
Bill
Large-cap
Broad-based
Treasury
Mid-cap
Equity
Equity
Bond
(Cash Equivalent)
Contract
Contract
Beta 1.10 1.29 0.80 1.0 0
Contract Price 2,875 2,350 3,000 $110,000* $100,000*
Multiplier 100 100 10 N/A N/A
Duration N/A N/A N/A 6.5 0.25
Expiration 0.25 years 0.25 years 0.25 years 0.25 years 0.25 years
*includes the effect of any multiplier
Michael presents a summary of client portfolios in Exhibit 3:
Exhibit 3
Summary of Current Client Holdings
Client Name Market Value of Holdings
Andrew Bolton $50 million invested in Fund A
Carly Dungan €100 million in Eurodollar deposits
Georgia Harrison $400 million invested in Fund D
Kathryn Lewis $100 million invested in Fund A
$50 million invested in Fund B
Isaac Jeffries $75 million invested in Fund B
Industrie des Eaux $350 million invested in Fund C
Andrew Bolton wants to reduce the level of portfolio equity risk and Michael
recommends reducing Bolton’s portfolio beta to 0.8 using futures contracts.
Carly Dungan requests that her portfolio be reallocated to a synthetic index fund of
European equities for the next three months.
Owen informs Michael that Georgia Harrison wants to change her portfolio mix to 80
percent bonds and 20 percent equity for the next three months, but retain the other
characteristics of Fund D. Michael decides this temporary reallocation will be
accomplished using futures contracts.
Owen reports that Kathryn Lewis wants to adjust her portfolio allocation so that she has
50 percent invested in Fund A and 50 percent in Fund B. Michael responds, “We can
restructure her portfolio by first buying U.S. Treasury bill futures to raise cash, then
selling U.S. large-cap equity futures and buying U.S. mid-cap equity futures.”
Isaac Jeffries is concerned that U.S equities are about to suffer a sharp downturn and
wants to convert his current holdings to cash for a period of 3 months.
Industrie des Eaux is a French company. Michael explains to Owen the currency risk that
this client faces from its investments with Platinum Investments.
43. In order to implement Michael’s recommendation for Bolton’s portfolio, the
number of U.S. large-cap equity future contracts that must be sold is closest to:
A. 24.
B. 26.
C. 33.
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44. In order to reallocate Dungan’s portfolio, the number of European futures
contracts that should initially be purchased is closest to:
A. 3,333.
B. 3,350.
C. 3,400.
45. In order to reallocate Harrison’s portfolio as requested, the number of bond
futures contracts that Michael should purchase is closest to:
A. 1264.
B. 1320.
C. 1454.
46. Michael’s plan for reallocating Lewis’ portfolio is most likely incorrect with
respect to:
A. buying U.S. Treasury bill futures.
B. buying U.S. mid cap equity futures.
C. selling U.S. large cap equity futures.
47. To achieve Jeffries’ objective, the number of U.S mid-cap equity futures contracts
that Michael will sell is closest to:
A. 319.
B. 322.
C. 332.
48. In her explanation regarding Industrie des Eaux’ currency risk, Michael should
focus on what type of exposure?
A. economic
B. translation
C. transaction
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