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QUESTION

(a) Assume that you have the resources to buy and hold the stocks in the Samp;P 500. You are given the following data. (Assume that today is January...

(a) Assume that you have the resources to buy and hold the stocks in the S&P 500. You are given the following data. (Assume that today is January 1.) Level of the S&P 500 index = 258.90 June S&P 500 futures contract = 260.15 Annualized Rate on T.Bill expiring June 26 (expiration date) = 6% Annualized Dividend yield on S&P 500 stocks = 3% Assume that dividends are paid out continuously over the year. Is there potential for arbitrage? How would you go about setting up the arbitrage? (b) Assume now that you are known for your stock selection skills. You have 10,000 shares of Texaco in your portfolio (now selling for 38) and are extremely worried about the direction of the market until June. You would like to protect yourself against market risk by using the December S&P 500 futures contract (which is at 260.15). If Texaco"s beta is 0.8, how would you go about creating this protection?

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