Questiоn 7B (10 pоints) Yоu hаve recently been promoted to senior portfolio mаnаger of a large equity fund. A junior portfolio manager submits the following recommendation: "We expect the stock market to decline over the next three months. The best strategy is to sell every stock in the portfolio immediately and move the proceeds into Treasury bills. If the market recovers unexpectedly, we can simply buy the stocks back. There is no reason to use derivatives because they simply increase risk and are primarily speculative instruments." As the senior portfolio manager, prepare a memorandum evaluating this recommendation. In your answer: Identify and explain at least six conceptual errors. Explain how derivatives can be used for risk management rather than speculation. Compare selling the portfolio with hedging the portfolio using stock index futures. Discuss the transaction-cost, implementation, and portfolio-management considerations involved in each approach.
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