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26 January, 02:30

Suppose that the standard deviation of monthly changes in the price of commodity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The correlation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commodity A

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  1. 26 January, 02:51
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    0.6

    Explanation:

    Correlation r = 0.9,

    Standard deviation of monthly change in price of commodity A, σA = 2,

    Standard deviation of monthly change in price of commodity B, σB = 3

    The hedge ratio will be calculated using the formula

    Hedge ratio=r*σA:σB

    Hedge ratio=0.9*2:3

    Hedge ratio = 0.6

    Therefore, the hedge ratio used when hedging a one month exposure to the price of commodity A is 0.6.
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