Advanced Financial Risk Management Regarding Pension Fund
A pension fund manager expects to receive an inflow of funds in 90 days and would like to invest some of the funds in a certain stock. The stock price today is $25. The fund manager would be very happy if, in 90 days, the stock was selling for $25. He asks you as a financial consultant to help him to make the decision.
Discuss the pension fund manager’s risk exposure if he remains unhedged. Show how the futures contract can be used to hedge the risk. What payoffs will there be for the hedged portfolio? If you use options to hedge the risk, which option would you choose, and what will the payoffs for the hedged position be? Explain why their net values are associated with different stock prices. Summarize the payoffs for the three hedging strategies: futures contract, option contract, and financial institution’s contract. Which hedging strategy would you recommend to the fund manager?