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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Derivatives

A portfolio manager holds a diversified equity portfolio worth Rs 5,00,000 with a beta of 1.0 relative to the Nifty. To reduce market exposure temporarily without selling the shares, the manager sells Nifty futures. Which description of this action is correct?

Selling Nifty futures against an existing equity portfolio is hedging. If the market falls, gains on the short futures offset losses on the shares, reducing systematic risk. It is not arbitrage or fresh speculation, and it does not increase risk.

  1. AIt is speculation because the manager is taking a new directional bet
  2. BIt is hedging because gains on the short futures offset losses on the portfolio if the market fallsCorrect
  3. CIt is arbitrage because it locks in a risk-free profit
  4. DIt increases the portfolio's market risk

Explanation

Selling index futures against an existing equity holding creates a short position that gains when the market falls, offsetting portfolio losses. This reduces market (systematic) risk, so it is hedging. It is not arbitrage because no risk-free profit is locked in.

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