Reference no: EM133073071
Q1) A trader owns 55,000 units of a commodity with current market price is $28/unit and the standard deviation of this spot price of is $.43. Use a cross hedge with futures for 5,000 units each; the current futures price for delivery at T is $27/unit and the standard deviation of this futures price is $.40; the correlation coefficient of the spot and the futures prices changes is .95. The trader uses the minimum, variance hedge ratio and hedges the value of the commodity for the next three months..
1.1 Calculate the minimum variance hedge ratio.
The risk minimizing hedge ratio: h*= -(0.95)(0.4)/(0.025) = -0.8837
1.2 What hedge should be opened? Why.
This should be a short hedge because the trader owns 55,000 unit and want to sell those in the future.
1.3 Calculate the optimal number of futures to be used in the hedge.
One future contract is: Nf = 5,000 units.
Short n* = (0.8837)[55000/5000] = 9.72 futures.
Q2) Suppose that three months later, on date k, the hedge in Q1. was closed.
2.1 Use a time table to show the end result of the hedge if the spot price at k was Sk =$25/unit and the futures price at k for delivery at T was Fk,T =$ $25.5/unit.
2.2 Instead of the data in 2.1, show the result of the hedge if the spot and the futures prices at k where $29/unit and $30/unit, respectively.
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