It is 25 July and you are considering a takeover bid for
the firm Hotshots whose current stock...

Question

It is 25 July and you are considering a takeover bid for
the firm Hotshots whose current stock price is $26 with a beta of 1.8. You are
going to purchase 100,000 stocks but not until 25 August. The stocks do not pay
dividends. The yield curve is flat at 5% p.a. (continuously compounded). The nearby
September-futures contract on the S&P 500 expires on 25 September (i.e. in
2 months). The price of Hotshots stock on 25 August is $27.9.

(a) If the S&P 500 index S0 = 1,000 on 15
July and S1 = 1,050 on 25 August, what is the futures index on these
two dates? 

(b) How might you hedge the cost of your purchases in
August, using a futures contract on the S&P 500 ($250 per index point)? 

(c) What is the outcome of your hedge? Explain.

Rochak · Accepted Answer

a. Futures Index
15th July = S0 * e^(5%*2/12)
= 1,000 * e^(5%*2/12)
= 1,008.37
25th August = S1 * e^(5%*1/12)
= 1,050 * e^(5%*1/12)
= 1,054.38
b. You will purchase the futures contract.

It is 25 July and you are considering a takeover bid for the firm Hotshots whose current stock price is $26 with a beta of 1.8. You are going to purchase 100,000 stocks but not until 25 August. The...

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