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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Introduction to Forwards and Futures

An investor has sold index futures to hedge a diversified equity portfolio. Which statement best describes the outcome of this hedge if the market rises?

When the market rises, the gain on the portfolio is offset by a loss on the short index futures position. A short hedge removes market risk by giving up potential gains along with potential losses.

  1. ABoth the portfolio and the futures position gain
  2. BThe portfolio gain is offset by a loss on the short futures positionCorrect
  3. CThe futures position gains while the portfolio loses
  4. DThe hedge locks in a gain larger than the market rise

Explanation

A short futures position loses when the index rises, offsetting the gain in the portfolio. This is the purpose of a short hedge, which reduces exposure to market movements. The other options misstate the direction of the futures payoff.

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