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26 March, 11:51

Suppose that the standard deviation of monthly changes in the spot price of commodity A is $20. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $24. The correlation between the futures price change and the commodity spot price change is 0.95. What hedge ratio should be used when using the futures contract on commodity B to hedge an exposure to a decrease in the price of commodity A?

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  1. 26 March, 11:55
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    The answer is 0.79166

    Explanation:

    The hedge ratio is given by correlation * spot A stddev / future A stddev

    The optimal hedge ratio is 0.95 * ($20/$24) = 0.79166
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