Options, Futures and Risk Management

Options, Futures and Risk Management
Finish four questions and Show all the calculation steps.
Part I
This part is to be read in conjunction with the data file “Data.xlsx”
You are managing an Australian equity portfolio, the details of which (portfolio components andweights) are described in sheet “Portfolio”. The current market value of your portfolio as of the 2ndof January 2014 is $150 million including cash. You are bullish about the market in the medium termbut are somewhat concerned about a potential “hiccup” in the coming earnings season wherecorporate earnings may come short of market expectation. As such you wish to implement aportfolio insurance strategy using the S&P/ASX200 index option (seehttp://www.asx.com.au/products/equity-options/options-contract-specifications.htm#XJO-Index forthe contract specification). Specifically you wish to hedgetill 20 March 2014, which is chosen tocoincide with the expiry of the March 2014 option contract.
1. Choose the maximum portfolio loss you would accept, given your view as described above.Base on this loss tolerance, identify the relevant put option out of the options given in sheet“OptionData”. Compute the number of contracts.

2. Based on the market data on the current day (2/1/2014), what is the cost of buying theseoptions? Does the cost look reasonable (to answer this question, compute the impliedvolatility of the option to be purchased and compared against historical volatility, the lattercan be estimated using data in sheet “EquityReturnData”. For the implied volatilitycalculation, use dividend yield of 4.5% p.a and risk-free rate of 2.42% p.a)
3. Following this purchase, what is the new composition of your portfolio (shares, cash, and options)?

4. Today is 20/3/2014. The option has expired, so does your hedging horizon. Evaluate theeffectiveness of your hedging by computing the current value of the portfolio and compareit against the value on 2/1/2014. Use the rate of 2.42% per annum for the cash component.
The index price for the settlement of the option is Are you happy with the hedge? Why/whynot?

These questions are to be answered in a Word document, with reference to an Excel file where youperform the calculation. The Word document is to be brief and concise.

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