Definition of Beta Hedge

Applying "Beta Hedge" to Securities Exams:

Here we will exam how to calculate a beta hedge based on a portfolio with a beta of greater than one using S & P 500 futures contracts. Aggressive managers may have to adjust the value at risk for their portfolios to hedge effectively based on the volatility or beta of their portfolios. A stock’s or portfolio’s beta is its projected rate of change relative to the market as a whole. If the market was up 10% for the year, a stock or portfolio with a beta of 1.5 could reasonably be expected to be up 15%. A stock or portfolio with a beta greater than one has a higher level of volatility than the market as a whole and is considered to be more risky than the overall market. A stock or portfolio with a beta of less than one is less volatile than prices in the overall market and is considered to be less risky. If the $160,000,000 portfolio above had a beta of 1.5, the manager would have to determine the beta?adjusted value at risk by multiplying the $160,000,000 value of the portfolio by the portfolio’s beta of 1.5. The beta?adjusted value at risk would now be $240,000,000. Now the manager must divide the beta?adjusted value of the portfolio to be hedged by the value of the S&P contract. In this case:

$240,000,000 ÷$400,000 = 600 contracts

Portfolio managers who oversee portfolios whose holdings may be included in other indexes may choose to hedge using futures on other indexes such as:

Nasdaq 100

Dow Jones Industrial Average

NYSE Composite

Russell 2,000

Value Line

Nikkei 225

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