On 1st March, 2020 an Investor has a portfolio of 5 shares as given Below

Security Price No of Shares Beta

1 400 1,000 0.90
2 450 1,000 0.78
3 900 2,500 0.65
4 1,200 3,000 1.16
5 8,000 1,500 1.10

Additional Information:
1. Cost of Capital is 14%
2. Current Nifty Value is 9,200
3. Lot Size is 50 only
4. Futures for June and July are quoted at 9,600 and 9,750 respectively

Find out:
1. Theoretical Price and Value of Futures Contract.
2. No. of Contracts to be traded if 70% of portfolio to be hedged.
3. No. of Contracts to be traded to reduce the Portfolio Beta to 0.20 using
June Futures.
4. No. of Contracts to be traded to reduce the Portfolio Beta by 0.10 using
June Futures.

Bharath M, Assistant Professor,

Seshadripuram Institute of Management Studies, Yelahanka, Bengaluru
Solution:
Computation of Portfolio Beta:
Security Value Weights(Wi) Security Wi βi
Beta (βi)
1 4,00,000 0.0214 0.90 0.0193
2 4,50,000 0.0240 0.78 0.0187
3 22,50,000 0.1203 0.65 0.0782
4 36,00.000 0.1925 1.16 0.2233
5 1,20,00,000 0.6417 1.10 0.7059
= 1,87,00,000 = 1.0454

Portfolio Beta = 1.0454

1. Computation of Theoretical Price and Value:

(Instructions for calculations: As the information for computation of Theoretical Price
and Value is not specified, as the information on June and July NIFTY is available, we have
to compute the Theoretical Price and Value for June and July.)

F = S0ert
Computation of Theoretical Price and Value for June:
S0=9,200, r = 0.14 and t = 4/12=0.3334
F = S0ert
F = 9,200 e(0.14*0.3334)
F = 9,200 e 0.0466
F = 9,200*1.04081
F = ₹9,575.452/Unit

Value = Theoretical Price * No. of Underlying in one contract

Value = 9,575.452*50
Value = ₹4,78,773
Computation of Theoretical Price and Value for July:
S0=9,200, r = 0.14 and t = 5/12=0.4167

F = S0ert
F = 9,200 e(0.14*0.4167)
F = 9,200 e 0.0583
F = 9,200*1.05127
F = ₹9,671.682
Value = 9,671.682*50
Value = ₹4,83,584

2. No. of Contracts to be traded if 70% of Portfolio is Hedged:

𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑺𝒑𝒐𝒕 𝑷𝒐𝒔𝒊𝒕𝒊𝒐𝒏 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑯𝒆𝒅𝒈𝒊𝒏𝒈

No. of Contacts to be traded = 𝒉 ∗ 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑶𝒏𝒆 𝑭𝒖𝒕𝒖𝒓𝒆𝒔 𝑪𝒐𝒏𝒕𝒓𝒂𝒄𝒕

If Hedged till June:

1,87,00,000∗70%
No. of Contracts to be traded = 1.0454∗
9,600∗50

No. of Contracts to be traded = 1.0454 * (1,30,90,000/4,80,000)

No. of Contracts to be traded = 1.0454 * 27.2708
No. of Contracts to be traded = 28.5088 that is 29 Contracts.

If Hedged till July:

1,87,00,000∗70%
No. of Contracts to be traded = 1.0454∗
9,750∗50

No. of Contracts to be traded = 1.0454 * (1,30,90,000/4,87,500)

No. of Contracts to be traded = 1.0454 * 26.8513
No. of Contracts to be traded = 28.0703 that is 28 Contracts.
3. No. of Contracts to be traded to reduce Portfolio Beta to 0.20:
VaSue of Spot Pocition Required Kedging∗(Miþi–Required Beta)
No. of Contacts to be traded = ℎ ∗ VaSue of One Futurec Contract

No. of Contracts to be traded = 1.0454 * 1,87,00,000∗(1.0454– .20)

9,600∗50

No. of Contracts to be traded = 1.0454 *1,58,08,980

4,80,000

No. of Contracts to be traded = 1.0454 * 32.9354

No. of Contracts to be traded = 34.4306 that is 34 Contracts

4. No. of Contracts to be traded to reduce the Portfolio Beta by 0.10:

VaSue of Spot Pocition Required Kedging∗(Miþi–Requir Beta)
No. of Contacts to be traded = ℎ ∗ VaSue of One Futurec Contract

(Instructions for Solving Problem: Here (𝑊𝑖𝛽𝑖 − 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝐵𝑒𝑡𝑎) will give the answer for reducing
the portfolio by ‘x’ number. Here in this question, they have given it directly as 0.10.)

1,87,00,000∗0.10
No. of Contacts to be traded = 1.0454 ∗
9,600∗50
18,70,000
No. of Contacts to be traded = 1.0454 ∗
4,80,000

No. of Contacts to be traded = 4.0727 that is 4 Contracts