Assignment Two – Equity Futures

Question 1
Assume it is now 17 January 2020 and the KLSE composite index is at 1146. The risk-free
interest rate is 5% p.a. The weighted average dividend yield of the KLSE composite index is
2.3% p.a. What would be the fair value of the June 2020 KLSE CI futures contract?

We now also have the following information:

• Spot price 1146.00
• Actual futures price 1192.50

a. Is the June futures contract mispriced?

b. How could you take advantage of this situation?

(5 marks)
Question 2
XYZ manage RM2,000,000.00 in the Malaysian Leaders fund, a portfolio comprised of blue-
chip Malaysian companies. They have performed well during the year with a systematic
approach involving the replication of the index through maintaining a combination of stocks
that perform similarly to the KLSE composite index and, where possible, picking stocks that
appear to be a “good value”. The portfolio currently has a beta estimated at 1.07.

In September, at a regular strategy meeting, the investment team conclude that, on the basis
of a number of technical and fundamental observations, there are extremely strong
indications the overall market is overheated and due for a severe decline in the short term.
The KLSE composite index is at 1110.50 and December KLSE CI futures are being quoted at
1115.

a. What does a beta factor measure?

b. What does the Malaysian Leaders beta of 1.07 say about the fund?
c. In September, given the market outlook described, what would be an appropriate
futures strategy to minimize risk?

During the second and third week of November, the market suffers a succession of falls, with
the result that the KLSE composite index is off 16.0 points from a high of 1165.20. The
investment team decides there has been a significant market over-reaction and that the
hedge should be lifted immediately. The portfolio now has a value of RM1,880,000.00 and
December KLSE CI futures are trading at 1003.00.

d. Assuming that the investment team decided on 80% protection, what would be the
appropriate number of futures contracts?
e. Calculate the profit and loss of the futures position
f. What was the overall result of the hedge?
g. Did the portfolio behave as the beta suggested it would? Explain your answer using
calculations.

(10 marks)