April 2009_q3 Clearly the graph above zero and below the "FTSE 100 index = 3000" can be hedged by buying a long Forward struck at 3000, at a cost of 10m (green part) Uploaded with ImageShack.us The addition of the two graphs will give (BLUE PART ONLY);- Uploaded with ImageShack.us Now to remove the part above zero, we sell a 5 – year FTSE call Option struck at 3000(Orange part). It is easy to see that the strategies will lead to a zero payoff. I don’t understand why the examiner’s report sells the forward and buys the call and how this strategy will result in a payoff of 10m/3 = 3.333m? I will appreciate some help.
The examiners report looks wrong. I think you are right. The report is describing a replicating portfolio and not the hedge. to get from one to the other you just swap the signs / buy vs sell. BTW you need to be more precise in your terminology. The forward doesn't "cost" 10m.
Thanks Elroy, I'l confirm when I get enough money to buy ASET. It should have actually been a forward contract to buy units of the FTSE index.
