Options, Futures and Risk Management Assessment

Assume you have AUD500,000 invested in an equal-weighted portfolio on April 1, 2022 for 3 months. The portfolio will comprise four Australian stocks: NCM, NST, EVN and PRU all of which are from the gold exploration and production sector. Identify a major risk in your portfolio of stocks to hedge with an appropriate futures contracts. (5 marks)

Assessment criteria:

• Identification of major risk
• Methodology for identification of major
• Rationale for selection of futures contract for

 Hedge your portfolio of Australian stocks with ASX SPI 200 Index futures over the same three months period (9 marks)

Assessment criteria:

• Rationale for using the hedge ratio
• Calculation of the hedge ratio
• Correct implementation of hedge, showing full details of transactions in a table with appropriate narrative of all relevant transactions that may occur in real world investment
• Correct liquidation of positions and calculations of profit/loss
• Effectiveness of the hedge and reasons why the hedge strategy worked/failed to work as you expect
• Discuss how the hedge can be improved taking into account the shortcomings you identified above 

For a better hedge, you believe it is simultaneously necessary to align with the expected future market state of the principal commodity. Using the term structure of futures contracts for the principal commodity, assess the market risk over the three months period.(5 marks)

Assessment criteria:

• Plotting the term structure
• Implication based on the curvature
• Potential market risk based on the curvature 

Based on your analyses of the term structure, determine a target beta to hedge again with ASX SPI 200 Index futures over the same three months period. At the end of the period, close all positions and evaluate the effectiveness of your hedge. Compare the results of this hedge with that using the portfolio beta. Briefly discuss the merits/demerits of both hedging methods.

Assessment criteria:

• Rationale for using the target beta
• Correct implementation of hedge, showing full details of transactions
• Evaluation of the strategy in comparison to the portfolio hedge

o Is one strategy necessarily superior than the other? 

REPORT WRITING. Your report must document a complete discussion of the process outlined above, including full details of transactions executed. Transaction costs must bear evidence that it is a realistic figure. Good structure, presentation and concise writing skills are likewise important. Your report length can be a MAXIMUM of word count of 3,000 words (size 12 font, 1.5 spacing), including all discussion, graphs, tables and references (3 marks)