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1. You are a fund manager with MC Asset Management Sdn Bhd. It is now end September and your current portfolio value is RM 7 million. You have done very well this year, having attained a 30% return thus far. However, you are worried about impending market volatility and wish to fully hedge your position over the next 3 months so as to ensure no erosion in your returns for the year. You have the following information. Rf = 6% per year Portfolio beta = 1.0 Expected dividends FBM KLCI spot = 0 FBM KLCI spot = 700 points FBM KLCI 3-month futures = 710.27 (maturing December) FBM KLCI 90-day options 680 December, put @ 2 points 700 December, put @ 8 points 720 December, put @ 22 points Assuming the FBM KLCI is at 630 points at end December (i.e 90 days later). a. Show how you could have hedged using index futures and the value of the portfolio at end December (graph the strategy). b. Show how you could have hedged using options and the resulting portfolio value at end December. What is the cost of the strategy in ringgit? Graph the strategy.

2. a. RM 20.00 calls and puts on Nestle stock of 90-day maturity are available. Yesterday, you bought a RM 20.00 call on Nestle stock at RM 1.55. The stock price was RM 19.60. Today the price has risen to RM 20.00. Assuming an rf rate of 8% and a standard deviation of 40%, determine the percentage return on your investment in the call option since yesterday. b. How does the % returns in (a) above compare with the % returns you would have gotten if you invested in the underlying stock? Briefly explain the difference. c. How would the call delta you computed in (a) compare with the call delta yesterday? Would it be higher or lower? Explain why. d. Your friend has 10 lots of Nestle stock (each lot = 1,000 shares) which he wants to hedge. Outline an appropriate hedge strategy using options. Determine the number of options that he should use.

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