Imagine you are a provider of portfolio insurance. You are establishing a four-y

Question

Imagine you are a provider of portfolio insurance. You are establishing a four-year program. The portfolio you manage is currently worth $70 million, and you promise to provide a minimum return of 0%. The equity portfolio has a standard deviation of 25% per year, and T-bills pay 6.2% per year. Assume for simplicity that the portfolio pays no dividends (or that all dividends are reinvested). What percentage of the portfolio should be placed in bills? Portfolio in bills %. What percentage of the portfolio should be placed in equity? Portfolio in equity %. Calculate the put delta and the amount held in bills if the stock portfolio falls by 3% on the first day of trading? Put delta % Amount held in bills $ million

Explanation / Answer

Answer: N(d 1 ) – 1 = 0.7422 – 1 = –0.2578.

Place 25.78% of the portfolio in bills,

74.22% in equity ($51.954 million)

At the new portfolio value, the put delta becomes –0.2779, so that the amount held in bills should be: ($67.9 million * 0.2779) = $18.86941 million. The manager must sell $0.826 million of equity and use the proceeds to buy bills

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