Case Study: Bea

Case 1: BEA Associates: Enhanced Equity Index Funds The following questions are meant to help focus your analysis of the case. You should do your best to evaluate the futures method of replicating the S&P 500 and then think more generally about the other options presented. Please turn-in a one page memorandum that describes your analysis and recommendations to BEA. (Note that your memo doesn’t need to answer all of these questions, but your analysis will likely require you to know the answers to these questions, as well as others.) I will also ask you to know answers to these questions in class. You may attach appendices for your calculations that do not have to fit on 1 page. 1) The traditional S&P500 index fund approach is to purchase the stocks in the index. What are the costs and benefits of this approach? 2) Calculate the theoretical futures prices and compare them to the actual futures prices using the various interest rates that are available. What do you conclude about the futures prices—are they close to the theoretical prices? Which interest rate do you believe is most relevant to BEA? 3) Carefully map out the transactions involved in using S&P futures to set up the portfolio to replicate the payoffs to the S&P. In particular, what is the margin invested in and what investments are made with the remaining cash? Which futures contract do you use? What will happen over time with your portfolio and what actions will you take to maintain its tracking of the S&P500? 4) What are your expected returns to your “Enhanced Index Portfolio?” 5) Do you best to explain the mechanics of the S&P 500 swap? Are there ways in which you can think about the swap that are similar to the way we think about futures? 6) Discuss the costs and benefits of the using the futures market, versus other alternatives, to mimic the S&P. In particular, you might think about taxes, default risk. 7) Is BEA’s historical performance that is presented in figure 2 consistent with an efficient