CMFAS M9A Risk Considerations of Structured Products question: fraction of a contract up

CMFAS M9ARisk Considerations of Structured Products

A manager wants to hedge a S$1,700,000 portfolio (beta 0.9 to the STI) using STI futures priced at 2,500 points with a S$10 multiplier. If he rounds any fraction of a contract up, so the hedge is not undersized, the correct number of contracts to short is:

A 61 contracts
B 68 contracts
C 76 contracts
D 62 contracts

Show the answer and explanation

Answer: D. 62 contracts

Price coverage per contract = 2,500 x S$10 = S$25,000. Hedge ratio = (S$1,700,000 / S$25,000) x 0.9 = 68 x 0.9 = 61.2. Contracts are indivisible and the stem says to round any fraction up, so he sells 62.

Common mistake

61 contracts rounds 61.2 down, which the stem rules out and which would leave the position under-hedged; 68 forgets to multiply by beta, and 76 divides by beta instead of multiplying.

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