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FRM Part I · FRM Exam Part I · Futures Markets

A portfolio manager holds an equity portfolio worth USD 50 million with a beta of 1.0 relative to the S&P 500. She wants to eliminate market risk completely for a short period using S&P 500 futures. Which position is appropriate?

She should short S&P 500 futures with a notional of USD 50 million. The hedge ratio is beta times portfolio value, and with a beta of 1.0 that equals the portfolio value. Shorting offsets losses in the stock portfolio if the market falls, whereas a long position would increase exposure.

  1. AGo long S&P 500 futures with a notional equal to USD 50 million
  2. BGo short S&P 500 futures with a notional equal to USD 50 millionCorrect
  3. CGo short S&P 500 futures with a notional equal to USD 25 million
  4. DTake no futures position, because a beta of 1.0 carries no market risk

Explanation

To hedge a long equity portfolio, the manager shorts index futures. The notional required is beta times portfolio value, which is 1.0 x USD 50 million = USD 50 million. A long position would double the market exposure, and a beta of 1.0 means full market exposure, not zero.

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