Investments, tenth edition

 Figure 23.4 

Predicted value of the portfolio as a function of the market index  

 Suppose the beta of the stock is 

2

⁄

3

, and the manager purchases $375,000 worth of the 

stock. For every 3% drop in the broad market, the stock would be expected to respond 

with a drop of 

2

⁄

3

  3  3%  5  2%, or $7,500. The S&P 500 contract will fall by 30 points 

from a current value of 1,000 if the market drops 3%. With the contract multiplier of 

$250, this would entail a profit to a short futures position of 30  3  $250  5  $7,500 per 

contract. Therefore, the market risk of the stock can be offset by shorting one S&P 

contract. More formally, we could calculate the hedge ratio as   

H

5

Expected change in stock value per 3% market drop

Profit on one short contract per 3% market drop

5

$7,500 swing in unprotected position

$7,500 profit per contract

5

 1 contract 

Now that market risk is hedged, the only source of variability in the performance of the 

stock-plus-futures portfolio will be the firm-specific performance of the stock. 

 Example  23.5 

Market-Neutral Active Stock Selection 

bod61671_ch23_799-834.indd   812

bod61671_ch23_799-834.indd   812

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  Futures, Swaps, and Risk Management 

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