Tutorial 3: Stock Index Futures Contracts

Question 1

a. State some of the benefits of transacting in stock index futures over stock market
transactions.
 Diversification Benefits /
Diversification benefits refer to reduction in risk as one diversifies across assets. This
diversification benefit in SIF arises from the underlying portfolio of stocks which constitutes
the index. Thus, purchasing a SIF contract is akin to buying each of the component stocks in
the index. According to Portfolio theory, investment in a broad range of stocks
reduces unsystematic risk.
invest in futures consider as buying 30 stock in market, no need buy one by one, buy the
index is copy the wi=eightage of component stock in KLCI. Buy sp500 = buy 500 stocks.
 Lower Transaction Cost
Several factors contribute to the lower transaction costs. Brokerage costs like commissions
are lower on a percentage of face value basis. The margins that need to be posted for SIF
contracts are also much lower relative to full payment on stock purchase. Transaction costs to
buy each and every single stock in the index separately are much higher than buying the stock
index future.
Buy SIF will get lower investment outlay, will lower transaction cost. If u buy from stock
market = higher cost bc u need to pay full amount
 Provides Leverage
Margins in SIF transactions means investment outlays that are much lower than transactions
in the stock market. It implies that there would be automatic leverage with SIF contracts.
Leverage is attractive, in particular to speculators since it implies a
higher return for a given investment.
Pay very less investment outlay, can increase buying power depends on initial margin

no need select stock, buy index u can gain exposure in the overall market, save some time for
investor to select the stocks, not plan to beat market, just follow whatever return provided by
market. Many etf do that, they follow the market. Invest in sp500, no need buy 1 by 1, just
buy etf.

Very common for hedger, want to transfer risk/hehdge the risk, instead of buying and selling
the position, can use this to temporarily hedge their position, not gonna dispose all, just want
to hedge temporarily. Sell in market transaction cost is higher, want to dispose lots of shares
in the open market, price will get lower n lower, so rather hedge it rather than sell while they
still able to receive dividend.

b. (i) What is systematic risk and unsystematic risk?

Systematic risk is the risk that remains even after one has put together a broad portfolio of
assets.

An investor can eliminate all unsystematic risk through diversification but would still be
faced with systematic risk

Whatever risk u identify can group under both of these two

Systematic risk = market risk,, affect all kind of investment regardless of what u purchase
Unsystematic risk happen to certain selected companies but not all, can diversify all the risk,
eg labour problems happen to certain firms. Like labour strikes like some manager treat
employee unfairly. Only firm specific risk, could happen to a firm. Full diversification of
portfolio, one or two stock happen this problem, others wont happen.

(ii)What risk do you face when you buy a single stock?

Unsystematic risk (can diversify away) and systematic risks (cannot diversify away)

(iii) What risk do you face when you hold a well-diversified portfolio of stocks?
Systematic risk (hold diversified portfolio alrdy diversify away all unsystematic risk)
not all the firms happen tgt, sometimes one or two stock got problem, other stock can protect
you. Those market risk canot diversify, hold many stock will still possible to have problem.
Hold any kind of investment also fall down during covid or inflation, political risk

c. If So= RM1010, rf=6% and annual dividend yield is 1.75%, what is the correct price of an SIF
contract expiring in
(i) 3 months; 

= 1010(1+0.06-0.0175)^(1/4)
=RM1,020.56 /
(ii) 6 months
=1010(1+0.06-0.0175)^(1/2)
=RM1,031.24 /

d. What impact would an increase in interest rate (rf) have on SIF prices? Why?
It will increase the SIF prices. This is because it will increase the carrying cost. Can put
higher rf number in formula, then can proof higher sif price by using higher interest rate in
formula

e. Why do SIF contracts have an index multiplier? What role does the multiplier play?

f. ndex multipliers are

intended to make SIF
contracts sufficiently large
for
g. institutional players
Index multipliers are intended to make SIF sufficiently large for institutional players.
Institutional players have higher exposure. This market initially intended for them to hedge
their risk. No multiplier what happen. If u fund manager 10-thousand million of stock. No
multiplier how to hedge this amount in the market? Not standardised by certain contract size.
If standardised alrdy can hedge their portfolio. Have multiplier, need lesser contract to fully
hedge their position.

If u sell soft drink, sell carton by carton (24 cans) or sell separately. Distributor sell carton is
easier than sell separately. For sif, Not dispose, temproraily reduce their risk or hedge their
position. Trade index just depend on market movement only. Pick the direction instead of
looking which stock to buy, if buy sif.

Question 2

You are currently holding a portfolio of stocks worth RM1,750,000. You wish to hedge your
portfolio. You have the following information:

Portfolio beta = 0.80

Spot Index value = 700 points

Risk-free rate = 5% per year

3 month SIF contract = 708.60 points

Expected dividend yield = 0%

Contract size = FBMKLCI multiplied by RM50

a. How many SIF contracts should you use to fully hedge your portfolio?
 Ringgit value of portfolio × Beta of portfolio
number of contracts=
Ringgit value of index
1,750,000× 0.8
¿
700 × RM 50
=40 contracts

b. Outline the hedge strategy and show the resulting portfolio value assuming the market falls
20% by futures maturity.
Action Position Position at Profit/Loss
today maturity

Long portfolio (1,750,000) 1,470,000 (280,000)

Short SIF 1,417,200 (1,120,000) 297,200

Dividend - - -

Net 17,200

Long portfolio, short SIF contracts.

Every hedging method is same, first need to find risk, then find how many contract. How to
see direction to hedge. Hope portfolio grow in value, so short the futures.

HEDGING can get negative value. Just to reduce risk. If all ppl can hedge with positive will
earn a lot of money alrd. So CAN GET NEGATIVE (smth like insurance, buy for protection,
to reduce the risk)

Question 3

You work at the Arbitrage Desk of MC Asset Management (MCAM), a fund management company.
Aside from managing stock portfolios, MCAM also does proprietary trading, largely index arbitrage.
You now notice the following quotations on your screen.
FBM KLCI index= 750 points

3-month SIF = 746.64 points (maturing 90 days)

Rf rate = 4%

Dividend yield = 1.75% (annualized)

Contract size= FBM KLCI multiplied by RM50

a. Proof that arbitrage is possible.

Arbitrage is possible whenever the Futures-Spot parity is violated.
F 0.25=S 0 (1+rf −d )0.25
¿ 750 ( 1+ 0.04−0.0175 )0.25
¿ 754.18
Since Ft<S0 (1+rf −d )t, the future is underpriced relative to the spot or the quoted futures
price is lower than what it should be.

Arbitrageurs enter market if theres any mispricing, first step is to see any mispricing happen
anot, input everything into formula. Figure is the theoretical future price. (754.18) quoted
value (746.64) lower than theoretical price (754.18)

b. Outline an appropriate strategy

Long SIF contract and short spot market.

c. Determine the arbitrage profit assuming the FBM KLCI is at 775 points in 90 days
Action Position Position at Profit/Loss
today maturity

Long SIF (37,332) 38,750 1,418

Short Spot 37,500 (38,750) (1,250)

lend RM37,500 @4% for 90 days (37,500) 37,875 375

Pay Dividend 1.75% x 37500 x 90/360 0 (164.06) (164.06)

Net 378.94
 Arbitrage is not gonna do something that give u loss. Must get profit. How to check answer
correct or wrong, must check whether final value is negative or positive. (negative is smth
wrong.)
d. To what extent is your arbitrage profit dependent on the FBM KLCI’s performance?
The size of the arbitrage profit will depend entirely on the extent of mispricing. Underlying
market movements will have no bearing on the profit.

Independent = not related to KLCI movement. Is the final answer correct, need to see this.
FBM KLCI at 775. Is the maturity value. Deswai all value u calc is 775. Whatever points u
use, will get 379 profit. KLCI move up to 2000 points, 500 points, is not related to ur profit.
Can do another payoff table, just change the maturity value (now is 775) change to 776, etc
will get 379 as profit. Another method to check u rans correct or wrong.
Check mispricing, position, then table.
Question 4

As the manager of a small equity fund, you are worried that the recent run-up in stock prices has
been too fast and a downturn may be due. You are therefore planning to “lock-in” the RM 9.6
million value of your portfolio. As a widely diversified portfolio, your beta approximates 1.0. You
have gathered the following information.

FBM KLCI = 800 points

FBM KLCI futures = 816 points

Futures maturity = 90 days

3-month KLIBOR (risk free rate)= 3.5%

Annual dividend yield of FBM KLCI = 1.5%

 a. Outline the appropriate strategy by which you can protect yourself from a downward
correction. (specify the number of contracts).
Short futures, long portfolio.
Ringgit value of portfolio × Beta of portfolio
Ringgit value of index
9,600,000× 1
¿
800× 50
= 240 contracts.

short 240 contracts to protect from downward correction(?)

b. Assuming the FBM KLCI is at 760 points in 90 days, determine the value of the hedged
portfolio.
F 0.25=S 0 ( 1+ rf −d )0.25
0.25
¿ 800 ( 1+0.035−0.015 )
¿ 803.97

Action Position Position at Profit/Loss

today maturity

Long spot (9,600,000) 9,120,000 (480,000)

Short SIF 9,792,000 (9,120,000) 672,000

Borrow @3.5% for 90 days 9,600,000 (9,684,000) (84,000)

Receive Dividend 1.5% x 9,600,000 x 90/360 - 36,000 36,000

Net 144,000
Hard to confirm whether the answer is correct anot.
if fully hedge position, ttry to do another wan with up or down movement. 760 point is
market fall down. Whatever point at the end, now 760 point to compute maturity value, use
300,400,500 u will get net profit 228,000. Net profit will not change as value lock there alrdy,
dun have extra risk alrdy. Got some differences if u not fully hedge. Means ur position is not
fully cover. Up n down will have some impact on u. today value no change.

c. How would you account for the change in the portfolio’s value from the original RM 9.60
million? Explain.

Original value is 9.6 mil, end u got hedger not care abt the loss. Hedge is for temporary only,
net losses also nvm for hedgers.

Question 5

As fund manager, you now hold a portfolio with a beta of 1.60. Worried about potentially huge
volatility over the short term, you wish to alter the beta of your portfolio to 1.0. Suppose the
current value of your portfolio is RM3.2 million and the spot index is at 1,000 points. Outline how
you could use SIF contracts for the above purpose (show all computation and clearly state the
strategy and number of contracts to be used).

Long portfolio, short SIF.

Amount of portfolio to hedge = Portfolio value x (1-(intended beta/actual beta))

= 3,200,000 x (1-1/1.6)
=RM1,200,000
No. of SIF contracts = 1,200,000 x 1.6 / (1,000 x 50)
= 24 contracts 38.4

net profit or loss is also 320,000 payoff is to proof whether can change the beta of portfolio to
1 (market beta). 38.4 contract can cover anot.
Follow how u do hedging punya calculation for 2688,000

0.4 odd lot must separate.

SSF and stock = position at maturity = same cuz no differences in beta.

Portfolio and (KLCI index futures) SIF are different thing, that’s why we need to adjust for beta.

Question 6

Maxis Bhd. Shares just went ex-dividend. The next dividend payment is at least 6 months away. The
risk-free rate is 6.5%. You notice the following quotes.

Maxis Bhd. Stock price = RM 9.50

3-month SSF contract on Maxis Bhd. = RM 9.85

a. Proof that the SSF contract is mispriced.

F 0.25=S 0 ( 1+ rf −d )0.25
0.25
¿ 9.5 ( 1+0.065−0 )
¿ 9.65
Since 3 month SSF contract is greater than F 0.25 ,it means that the SSF contract has been
overpriced.

b. Outline the appropriate arbitrage strategy.

Short SSF, long the underlying stock.

c. If you invest an amount equal to about 10,000 shares, what would your profit be at SSF
maturity if Maxis Bhd. Stock is higher by 10%?
Action Position Position at Profit/Loss
today maturity
 Long stock (95,000) 104,500 9,500

Short 10 SSF 98,500 (104,500) (6,000)

Borrow @6.5% for 90 days 95,000 (96,543.75) (1,543.75)

Receive Dividend - - -

Net 1,956.25

d. What would your profit be if Maxis Bhd. Stock fell 10% instead?

RM1,956.25