Question

Question completion Status QUESTION 6 The monthly standard deviation in the price of bacon (in cents per pound) is 1.3. The futures contract whose price movements have the closest correlation to those of bacon is that for pork bellies. The standard deviation of pork bellies is 1.4, and the correlation between bacon an pork bellies is.9. A bacon producer wants to hedge its production, three months from now, using pork belly futures. The producer's production amount will be 200,000 pounds of bacon. Each futures contract is for 40,000 pounds of pork bellies. What strategy should the bacon producer follow? The producer should buy pork belly futures. The producer should sell pork belly futures. QUESTION 7 How many pork belly futures contracts should the bacon producer trade? State your answer as a whole number, as these contracts are not divisible. QUESTION 8 The previously described strategy leaves the producer unhedged for a certain amount of bacon production. How many pounds of production remain unhedged? Round to the nearest whole number and do not enter units.

please shown in steps

Answer 1

The optimal hedge ratio is

$r=\rho *\frac{\sigma _b}{\sigma _p}$

r= 0.9*(1.3/1.4) = 0.84

The bacon producer should create a long position in= 200,000*0.84=168,000 lbs in pork belly

therefore take a long position in 168,000/40,000= 4.2 i.e 4 contract

the bacon remain un-hedged = (4.2-4)*40000= 8,000 lbs belly

8000 belly = 8000/ 0.84 = 9523 lbs of bacon

Answer 6) The producer should buy the pork belly futures

Answer 7) 4 contract

Answer 7) 9523 lbs bacon