Introduction
The purpose of the project was to see if using futures contracts to hedge can reduce exposure to market risk over a period of time. This project covered both stock portfolios and bond portfolios. To illustrate this, the method of linear regression and least squares was used. We used linear regression to regress the spot rate against the futures contract return. To complete this project both EViews and Microsoft Excel was used.
Summary of Points
Stock Regression 2008-2009
Around 96% of the stock portfolio returns can be explained. This was calculated by finding the variance proportion, r2 in EViews. The high percentage suggests that our model is a strong fit for the data that was analyzed.
We were also able to show that our estimated beta was reliably different than 0 and reliably different than 1. This was done through two-sided tests using a 95% significance level. The tcrit value was found using the excel function tinv() with 497 degrees of freedom.
Testing for B=0, the t-statistic was 110.087, with the tcrit value being 1.964 this was a clear indication to reject the null because 110.087 is not in the range of -1.964 to 1.964.
Testing for B=1, the t-statistic was -3.37853, with the tcrit value being 1.964 this was also a clear indication to reject the null because -3.37853 is not in the range of -1.964 to 1.964.
After finding the optimal hedge ratio we calculated the dollar position for the futures market hedge to be $9,702,250. By using excel to compare the stock portfolio returns without hedging to the use of a futures contract hedge we were able to see the calculated benefits of the hedge option. By looking at the maximum dollar loss and standard deviation of both options it was clear that using a futures contract to hedge daily dollar loss was not useful. On the other hand the standard deviation of the hedge option