US WEST Portfolio Insurance

ISBN 0-538-88688-9

Case Teaching Package
A case teaching package is available for this case. It includes strategies for case presentation, key concepts, solutions to the assignment questions in the case, and suggestions for the most effective ways to work this case into your course.

Length
This case is 14 pages in length and its case teaching package is 8 pages.

Abstract

In 1986, US WEST hired an external manager to implement a portfolio insurance strategy for the pension fund's $3 billion equity portfolio. The manager's task involved shifting as necessary between relative percentages of "equity" and "cash," using trades in financial derivatives to effect the shift and arbitrage to improve the fund's performance.

On October 19, 1987, however, the stock market crashed precipitously, severely affecting US WEST's pension equity portfolio. Although the futures market was behaving erratically and the US WEST equity portfolio was already quite exposed because of its futures position, the manager wished to short $1.2 billion in S&P 500 futures to raise the portfolio's cash position and offset equity losses. The manager's proposal was in keeping with its portfolio insurance strategy, but US WEST's pension fund managers were concerned about exposing the portfolio more than it already was. In addition, they were alarmed by the sums already owed them for unpaid marks to the market, as well as the amount of cash they would have to pay out in margins and marks to the market if they permitted the manager to execute the insurance strategy fully. Finally, they wondered whether insurance strategies of US WEST and other institutional investors were contributing to the instability in the market.

Fit Within a Course/Linkages to Textbooks or Journal Articles

This case is intended for advanced undergraduate finance students or MBA and executive-education students. It may be used in courses devoted to portfolio management, equity analysis, securities analysis, options and futures, or risk management. The case lends itself well to in-class discussion. For this reason, the teaching plan consists of discussion questions for the class and suggestions for how students may respond.

Two lengthy studies of the causes of the stock market crash are

• Report of the Presidential Task Force on Market Mechanisms, Nicholas Brady et. al., U.S. Government Printing Office, 1988.
• An Overview of Program Trading and Its Impact on Current Market Practices, Nicholas Katzenbach, Study Commissioned by the NYSE, December, 1987.