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Hedging and Overlay Decisions

Choose and size overlays, quantify residual risk, and set conditions to adjust or unwind.

These prompts are original practice. They are not questions from a named employer or a live hiring loop.

Equity beta overlay

A $100m fund has market beta 1.15. The manager wants beta 0.85 for one month. Each index futures contract contributes $250,000 of beta exposure. Ignore fees for sizing.

  1. 1.What beta-dollar exposure is currently held?

  2. 2.What exposure is the target?

  3. 3.What hedge notional is needed?

  4. 4.How many contracts does that require?

  5. 5.What hedge P&L follows a 5% index decline?

  6. 6.What net first-order P&L follows the decline including the original portfolio?

  7. 7.If the index rallies 5%, what cash outflow might the hedge create?

  8. 8.What if portfolio beta falls to 0.95 at unchanged NAV?

  9. 9.What would support shrinking the overlay?

  10. 10.What should the committee review separately?

Rate duration target

A bond fund has positive DV01 of $62,000 and wants $40,000. A short futures contract reduces DV01 by $220. A 25 bp rise is the main stress. Use linear sensitivities.

  1. 11.How much DV01 needs removing?

  2. 12.How many short contracts fit the target?

  3. 13.What is original first-order loss in the main stress?

  4. 14.What does the hedge gain in that stress?

  5. 15.What is net first-order loss?

  6. 16.If portfolio DV01 drops to $55,400 after bond sales, how many short contracts maintain target?

  7. 17.How many existing shorts must be bought back after those sales?

  8. 18.Why test a steepening shock too?

  9. 19.What if the cheapest deliverable changes and hedge DV01 falls?

  10. 20.Why track spread duration after implementing this hedge?

Currency hedge

A dollar portfolio holds €20m of assets and wants to hedge 70% of euro exposure for three months. It sells euros forward at $1.10. Ignore forward carry for shock calculations and use settlement spot of $1.02 in the downside scenario.

  1. 21.What euro notional should be sold forward?

  2. 22.What residual euro exposure remains?

  3. 23.What is the forward's payoff at $1.02 per euro?

  4. 24.What is the portfolio's currency-only loss relative to $1.10 before the hedge?

  5. 25.What currency loss remains after the hedge?

  6. 26.If the euro holdings grow to €25m, what is the new 70% target?

  7. 27.What extra forward notional is needed in that case?

  8. 28.What if the foreign assets also fall in local price?

  9. 29.Which funding issue should the manager check before roll?

  10. 30.When is a full rather than partial hedge appropriate?

Protecting the left tail

A fund owns 50,000 share equivalents at $100. It considers 500 put contracts with multiplier 100 and strike $90. Premium is $2 per share. Alternatively it buys the $90 put and sells a $75 put for net premium $1.20. Assume expiry analysis and no fees.

  1. 31.What premium does the outright put cost?

  2. 32.What is the put spread premium?

  3. 33.What is the put spread's maximum gross payoff per share?

  4. 34.At $85 expiry spot, what is the outright put's net payoff per share?

  5. 35.At $70 spot, what is the spread's net payoff per share?

  6. 36.At $70 spot, what is the outright put's net payoff per share?

  7. 37.At $95 spot, what happens to both option packages at expiry?

  8. 38.Which protection better addresses losses below $75?

  9. 39.What if the fund liquidates half the shares before expiry?

  10. 40.Which observation could trigger rolling before expiry?

Credit overlay

A portfolio has $48k spread DV01. A short credit-risk overlay gains $8k per bp widening for each $10m of overlay notional. The manager wants $24k net spread DV01. The overlay costs $90k over the hold.

  1. 41.What spread DV01 should be hedged?

  2. 42.What overlay notional matches that reduction?

  3. 43.What is the unhedged loss in a 50 bp spread widening?

  4. 44.What does the overlay gain in that scenario before cost?

  5. 45.What net loss follows after including the $90k cost?

  6. 46.If the overlay gains only $0.6m, what net loss follows including cost?

  7. 47.What could cause that weaker protection?

  8. 48.What remains if rates rise but issuer spreads do not move?

  9. 49.Why review counterparty and collateral terms?

  10. 50.What would justify replacing an index hedge with a narrower one?

Cash equitization

A $200m fund has $16m of cash reserved for staged stock purchases. It wants $12m of interim index exposure. Each future represents $300k of index notional. Futures are authorized with a separate cash margin buffer.

  1. 51.How many long contracts provide $12m of exposure?

  2. 52.Why keep the cash reserve after buying futures?

  3. 53.After $6m of unit-beta stock purchases, how many futures should remain to keep incremental exposure at $12m?

  4. 54.How many contracts should be sold to get there?

  5. 55.If only $3m of the planned stock purchase confirms, how many futures should remain?

  6. 56.What is the risk of unwinding futures on order entry rather than fills?

  7. 57.What if the purchased stocks have beta 1.3 per dollar?

  8. 58.What if no margin cash remains after a stressed decline?

  9. 59.What if the staged purchase schedule extends past expiry?

  10. 60.What should the performance attribution show?

Choosing between hedges

Two eligible overlays each target a $4m stressed loss reduction. Overlay A costs $0.15m and delivers $3.8m in the target stress and $0.5m in an alternative shock. Overlay B costs $0.30m and delivers $3.4m and $2.0m respectively. The mandate needs at least $1m net protection in each shock.

  1. 61.What target-stress net protection does A provide?

  2. 62.What alternative-shock net protection does A provide?

  3. 63.What target-stress net protection does B provide?

  4. 64.What alternative-shock net protection does B provide?

  5. 65.Which overlay meets both minimums?

  6. 66.How much greater is A's net protection in the target scenario?

  7. 67.If B's alternative payoff halves, does it still meet the minimum after cost?

  8. 68.What should the committee hear about the choice?

  9. 69.Which issue could change the recommendation despite modeled payoffs?

  10. 70.What monitoring rule reflects the binding requirement?

Overlay funding

A short futures hedge has $4m initial margin posted. A rally triggers a $3m cash variation margin payment at noon and a $1m initial margin top-up. Free cash is $3.5m. The long holdings gain $5m on paper. A $2m inflow arrives after noon.

  1. 71.What incremental cash is due at noon?

  2. 72.What noon gap remains without other funding?

  3. 73.Does the paper gain fund the noon call by itself?

  4. 74.What does the later inflow change for noon?

  5. 75.What if the manager also needs $1m minimum free cash after paying?

  6. 76.Why separate initial and variation margin in the report?

  7. 77.What hedge redesign might reduce cash pressure?

  8. 78.Which downside still matters with a paid-premium option?

  9. 79.What evidence belongs in the hedge proposal?

  10. 80.What would justify shrinking the hedge under cash stress?

Cross-asset overlay

A $100m fund is long $60m equities and $40m bonds. A stress projects equities −10% and bonds −5%. An index short gains 10% of its notional. A rate hedge gains $1m in the scenario. The committee caps stress loss at $4m and ignores hedge costs for initial sizing.

  1. 81.What unhedged loss does the portfolio face?

  2. 82.How much protection is needed to reach the limit?

  3. 83.After the rate hedge's gain, how much must the equity short provide?

  4. 84.What equity short notional produces that protection?

  5. 85.If the index falls only 6%, what does the $30m short gain?

  6. 86.In that basis scenario, with original asset losses and rate gain unchanged, what net loss follows?

  7. 87.What if the bond loss is mostly issuer spread widening?

  8. 88.What should the combined overlay be tested against?

  9. 89.What should guide trimming a physical sleeve instead?

  10. 90.What is a useful escalation if no feasible hedge meets the cap?

When to unwind

An overlay was approved for a four-week event window. Its initial target was $20m of hedge exposure. After asset sales, the verified target falls to $12m. The event has passed, but the committee still requires $12m for a remaining one-week risk.

  1. 91.How much hedge exposure should be removed to reach the new target?

  2. 92.Why avoid closing the entire hedge immediately?

  3. 93.What should the unwind plan account for?

  4. 94.What evidence should confirm the new target?

  5. 95.What if the hedge's market liquidity worsens suddenly?

  6. 96.How should a committee interpret losses on the hedge in a rally?

  7. 97.What if the original rationale disappears and no other risk target remains?

  8. 98.What trigger should be documented for the final one-week hedge?

  9. 99.What should be checked after unwind orders execute?

  10. 100.What should the postmortem attribute?

  11. 101.Which finding would justify changing the next event playbook?