Which of the following is a reason for hedging a portfolio with an index futures? A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market. B. The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well. C. The portfolio is not well diversified and so its return is uncertain. D. All of the above.
Question
Which of the following is a reason for hedging a portfolio with an index futures?
A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market.
B. The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well.
C. The portfolio is not well diversified and so its return is uncertain.
D. All of the above.
Solution
The correct answer is:
A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market.
Here's the reasoning behind this choice:
Hedging a portfolio with an index futures contract can help to reduce the risk associated with market fluctuations. This can be particularly useful if an investor believes that the specific stocks in their portfolio will perform well, but they are uncertain about the overall direction of the market. By hedging with an index futures contract, the investor can protect their portfolio against potential losses if the market performs poorly.
Option B is not a reason for hedging. If the investor believes the market is expected to do well, they would want to fully participate in the market's gains, not hedge against them.
Option C is not a reason for hedging with an index futures. If the portfolio is not well diversified, the investor should consider diversifying the portfolio rather than hedging it.
Therefore, option D is also incorrect.
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