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What is the optimal hedge ratio

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An airline company expects to purchase three million gallons of jet fuel in one month and decides to use heating oil futures for hedging. The standard deviation of monthly changes in the spot price of jet fuel is $0.0285, and the standard deviation of monthly changes in futures price of the heating oil is $0.0320. The correlation between the futures price changes and the spot price changes is 0.965.

(1) What is the optimal hedge ratio and what is its interpretation?

(2) Each contract is for the delivery of 40,000 gallons of heating oil. How many contracts are needed to hedge the position?

(3) Should the company go long or short these futures contracts? Explain your answer.

Reference no: EM132955721

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