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Practice

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Answers to Selected Practice Exam Questions 1. A pension fund holds $50 million portion of its portfolio in an indexed position of the NASDAQ 100, which has a dividend yield of 0.75 percent. It would like to convert that position to the risk-free asset for a two-month period as it forecasts bad news in the economy. It has decided to do this using a two-month futures contract on the NASDAQ 100, which is priced at $148472, per contract. Each contract consists of 100 times the index. The risk-free rate is 4.65% (no compounding). Describe the strategy to synthetically convert the position to the risk-free asset for 2 months. N = -50MM*(1.0465)^(1/6)/(148472) = -339 contracts 2. A hedge fund holds $50 million of large-cap domestic equity with a beta of 1.5 with respect to the S&P 500 index. It would like to move from large-cap stocks to small-cap stocks for the next three months because it forecasts that small-cap stocks will have a positive alpha over the next three months. It also forecasts that the market will do well over the next month and targets a beta of 3 with respect to the S&P 500 index. Develop a strategy that can achieve both these goals (i.e capture alpha with respect to small-cap stocks and achieve a beta of 3) simultaneously You can use the following details for the above problem: The S&P 500 index is currently trading at 500. A two month futures contract on 100 units of the S&P500 index has a price of $50502. The Small Cap index is currently trading at 1000 and has a beta of 2 with respect to the S&P 500 index. A three month futures contract on 100 units of the Small Cap index has a price of $101005. Assume that neither index will pay dividends over the next three months. Futures on S&P500 to Sell =-1.5*(50*1000000/(500*100)) = -1500 futures Futures on Small Cap to Buy =(3/2)*(50*1000000/(1000*100)) = 750 futures

MCQ: 6 d. 7. b 8. a.

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