Question

A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is $28 and the standard deviation of the change in this price over the life of the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation between the spot price change and futures price change is 0.95. (a) What is the minimum variance hedge ratio

Answer 1

Minimum variance hedge ratio = 1.02125

Step-by-step explanation:

Given:

Standard deviation of related hedge $0.43

Standard deviation of related hedge = $0.40

Correlation coefficient = 0.95

Find:

Minimum variance hedge ratio

Computation:

Minimum variance hedge ratio = Correlation coefficient[Standard deviation of related hedge / Standard deviation of related hedge ]

Minimum variance hedge ratio = 0.95[0.43/0.40]

Minimum variance hedge ratio = 1.02125