Hedging Strategies and Portfolio Management - A Case Study

Scenario 1: Hedging Unleaded Gasoline with NYMEX Futures

Q1. Your company, which requires unleaded gasoline, is considering hedging. Assume that the company unleaded gasoline at the beginning of each month; the futures traded on the NY Mercantile Exchange (NYMEX) are delivered to NY harbor. Using weekly data from January 2007 till the end of 2019 from the US EIA at DOE [the Energy Information Administration, a part of the Department of Energy,, on spot and futures prices, find the minimum-variance hedge ratios for gasoline alone, cross-hedged against crude oil, cross hedged against heating oil. Evaluate the effectiveness of your hedge.

To answer this question, you need to prepare a 1-page report that contains the following elements:

1. A one-sentence statement of the futures position you would undertake.

2. Present the estimated regression equation that determined your hedge.

3. For the evaluation period, compute the gain or loss for the hedged and un-hedged positions in dollar terms.

Q2. Assume you have 5,000,000 (1 million) in cash. Create an equally weighted portfolio of 30 stocks traded on S&P 500 based on the closing prices for January 31, 2020. You want to use the three-month futures contract on S&P 500 to (a) hedge the beta of your portfolio (b) double the beta of your portfolio.

To answer this question, you need to prepare a 1-page report that contains the following elements:

1. Report the beta f your portfolio by either estimating it or using the betas reported on Yahoo Finance.

2. Describe how many S&P futures contracts you buy or sell in either case.

3. The evaluation period is from February 10 till February 17. For the evaluation period, verify that the performance of your combined portfolio.

Q3. Consider the following Morgan Stanley bond.

Issuer Name Coupon Maturity

For simplicity, let us assume that the cheapest-to-deliver bond underlying the futures contract will have the following characteristics at the time of delivery in March 2020: 20 years to maturity, a 5 percent coupon, and a yield-to maturity of 4%.

Along the way, be sure to state the duration of each bond, and be very clear about the position you would take in the futures market.

you need to explain what you have done.

Q4. On January 30, 2020, a company is interested in hedging their bond portfolio. In 2016, they purchased at par $250 million of a corporate bond 2016-2031, a 5.50 percent coupon bond issued by the Big Company with maturity on September 28, 2031. The current clean price of the bond was 121.94. The manager of the company is alarmed by rumors concerning a possible increase of interest rates. He had asked you (his assistant) to see how the bond could be hedged using the December 2016 Bond futures. The contract size is $100,000 the notional coupon is 6% and maturities for the underlying bonds are 8.5 to 10.5 years. The quoted futures price is 122.53. You ran a regression of past price changes for the bond (ΔS) regressed on the futures price changes (ΔF) over the past month (using daily data):

ΔS = 0.71 ΔF R² = 0.35

How many futures contracts should be bought or sold to minimize the risk of the hedged position? Verify how your hedge works