You Want to Invest $1 Million in the S&P 500

question 96

Essay

You want to invest $1 million in the S&P 500 index for one year.There are two ways to go about it.You could actually buy all the stocks in the index according to their index investment weights,or you could buy an S&P index futures contract (and put the $1 million in a risk-free investment for one year).The S&P index is now at 350,and an S&P index future with a one-year maturity is selling at 355.The riskless rate is 8%,and the dividend yield on the S&P index is 6%.Assume that the S&P contract size is equal to the index,and that all cash flows to the future occur at maturity (i.e.,there is no daily resettlement).
a. What should you do and why?
b. Under your strategy for part a, how much money will you have at the end of the year if the S&P index closes at 380?

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