Optimal hedge ratio with futures which expire later than holding period


New Member
Write down the optimal hedge ratio equation for a stock portfolio and use the information provided to solve the hedging problem.

Assume a fund manager has a £5 million portfolio of shares with a beta risk of 0.87. Price risks are apparent in a two –month holding period horizon.

The only front month stock index futures contract available to you expires in three months. The stock index (spot) is quoted at 1250 and has a multiplier value of £25. The risk free rate is 6% and the dividend yield is 3%. What is the fair futures price of the index.

If you can only use a 3 month futures index to hedge your exposure, determine the
hedge ratio. How is this hedge ratio likely to impact on the hedge effectiveness of position over a two month horizon.