On 31st August 2019, a long-term client, Mr Robin Baldwin, constructed a stock portfolio

Assume that you are one of the highly skilled specialists in ANZ Market Solutions team, which was formed to develop the right advice on risk management solutions and the implementation of derivative strategies for ANZ’s customers. You have been asked by the Director to prepare a report that addresses all the tasks required in the following five scenarios. Note that scenarios are independent of each other.

SCENARIO 1: HEDGING WITH STOCK FUTURES

On 31st August 2019, a long-term client, Mr Robin Baldwin, constructed a stock portfolio that consists of any five Australian stocks among ten stocks listed in Exhibit 1. He intended to hold the portfolio for one year and sell it on 31st August 2020.

Exhibit 1: List of stocks

On 25th February 2020, Australia confirmed its first four Covid-19 cases – one in Victoria and three in NSW. Globally, eleven countries confirmed coronavirus cases with a total of 1,320 cases, and 41 people had died (The Guardian, 2020). Mr Robin was concerned about the spread of the new coronavirus outbreak and how badly coronavirus would hurt the Australian stock market. He asked you to set up a hedge against his portfolio’s market risk using September ASX SPI 200 index futures. He expected the hedge to be in effect at the close of trading on 25th February 2020, on which day the September futures contract was traded at 6,826. The contract multiplier is AUD 25 per index point.

Task 1.1: The goal of this task is to investigate how index futures can be used to minimise the market risk from holding the stock portfolio. In particular, you need to determine the number of futures contracts for the hedge and report the position in futures contracts to be taken.

Task 1.2: Determine the outcome of the hedge on 31st August 2020, on which day the September contract was priced at 6,030. Based on this outcome, discuss whether your client regretted having the stock portfolio hedged or not?

Hints:

• Note that the selection of five stocks included in Mr Robin’s portfolio is your own choice. Naturally, each student will end up with a different portfolio of five stocks. The number of shares for each stock chosen must follow Exhibit 1. For example, if Afterpay Limited is selected, Mr Robin would hold 15,000 shares of this stock in his portfolio.

• Daily stock prices can be obtained from Yahoo Finance website: https://au.finance.yahoo.com/ (Search the company name/symbol => Select “Historical Data” Tab => Choose the relevant time period then click “Apply” and “Download”. Please use “adjusted close price”.)

• To complete the tasks, you will need to self-calculate beta for each stock at the start of the hedge (on 25th February 2020). Beta is a measure of systematic risk of a security or portfolio compared to the market as a whole. Steps to compute beta for any stock using Excel is as follow:

(1) Download 2-year historical daily prices for a stock whose beta you want to measure.

(2) Download historical daily prices for the market index S&P/ASX 200 (^AXJO)

(3) Calculate the daily returns (i.e. % change) of (1) and (2).

(4) Find beta of the stock by using the Excel function = SLOPE (Y, X)
where Y is the daily returns series of the stock, and X is the daily returns series of ASX
200 index, calculated in step (3).

Hint

ManagementHedging refers to a risk management approach used to offset losses in stocks by taking an opposite position in an associated asset. The discount on risk stipulated by hedging also naturally results in a reduction in possible profits. Hedging approaches naturally include derivatives, like options and investments contracts...

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