The following is part of the computer output from a regression of monthly returns on...
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Accounting
The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 Index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month.
| Beta | R-square | Standard Deviation of Residuals |
|---|---|---|
| 0.75 | 0.65 | 0.03 (i.e., 3% monthly) |
Required:
a-1. If he holds a $13.6 million portfolio of Waterworks stock and wishes to hedge market exposure for the next month using one-month maturity S&P 500 futures contracts, how many contracts should he enter? The S&P 500 currently is at 2,000 and the contract multiplier is $50.
a-2. Should he buy or sell contracts? multiple choice:
Sell
Buy
b. Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month? Assume the risk-free rate is 1.2% per month. (Do not round intermediate calculations. Round your percentage answer to 2 decimal places.)
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