Question

1. A cocoa merchant currently has a cocoa inventory worth approximately $10 million at current spot of $1840 per metric ton. Cocoa future trade on the coffee, cocoa and sugar exchange with contract size equal to 10 metric tons. Current price for a May contract is $1630 per metric ton. She would like to hedge with a minimum variance hedge ratio so she calculates some statistics. The standard deviation of return for her inventory is .27. the measured volatility of future contract price is .33. the correlation between the spot cocoa and future contract rice is .85. a. Compute the current number of metric tons in inventory base on the current price . calculate the minimum variance hedge ratio and optional number of contract to hedge with. b. Should she go short or long with her position? Explain. c. IF the May contract close at $1725 and convergence occurs, calculate the gain / loss on the hedge position, was the hedged successful? Explain.

Answer 1