Question

1. A food processing company knows that it will buy 1 million bushels of corn in three months. The standard deviation of the change in the price per b of bushel over a 3-month period is calculaed 0.055 (5.5%). The company chooses to hedge by buying futures contracts on corn. The sandard deviation of the change in the futures price over 3-month period is 0.065 (6.5%) and the coefficient of correlation between the 3-month change in the price of com and 3-month change in the futures price is 0.75. a. What is the optimal hedge ratio? b. One Corn contract is 50,000 bushels. How many contracts should the company entered? 2. Today's Dec 2010 Ethanol settlement price was $1.97 per gallon. Suppose that when the contract matures in December, the price of Ethanol turns out to be $2.07 per gallon a. What will be the profit or loss be for the long position trader who entered the contract at the futures price? b. If each contract calls for delivery of 29,000 gallons what would the dollar profit/ loss be to the long position trader?

show all work. show all calculations.

Answer 1

Both the questions are asked based on derivatives
e four * 1 a) Optimal hedge ratio os x Correlation is where "os" is the standard deviation of change in spot price of is the std deviation of change in future Accordingly hedge ratio is calculated given os= 0.055, of = 0.OGS, CorFs = 0.75 = 0.055 80.75 10.635 | 0.065 No of futures contract to be traded Hedge & units in spot position requiring hedging ratio No of units underlying one future contract Given 1 com contract = 50000 bushels 16) - = 0.635 x 1000000 =(12169 or 12 contracts. 50000

SL-101 oba to 1) For a tong position trader Profit is profit = $2.07 - $1.97 = 0.108 2b As given in the problem there are total 29000 gallons so the profit for the long position trader will be = 29000 gallons x 0.10$ = $29000 notes :- 1) profit on maturity is calculated ise, maturity Price - settlement price 2) For [26] ans we used the formula profit x total gallons.