Question

"Suppose the scenario that the standard devation of semiannual changes in the price of wheat is $0.79, the standdard devation of changes in the futures contract on wheat over the same tim eperiod is $0.93, and the correlation coeffieient relating the assest and futures contract is $0.86. What is the optimal headge ratio for the six month contract on wheat

Answer 1

The optimal Hedge Ratio is 0.7305.

Explanation:

Optimal Hedge ratio is given as

`HR_(optimal)=\epsilon_(correlation) * (\sigma_(current))/(\sigma_(future))`

Here

• HR_optimal is the Hedge Ratio for the next 6 months which is to be calculated.
• ε_correlation is the correlation coefficient relating the assets and futures contract whose value is give as $0.86.
• σ_current is the standard deviation of the semiannual changes of the wheat which is given as $0.79

• σ_future is the standard deviation of the changes in the future over the same time period which is given as $0.93

So the Hedge Ratio is given as

`HR_(optimal)=\epsilon_(correlation) * (\sigma_(current))/(\sigma_(future))\\HR_(optimal)=0.86 * (0.79)/(0.93)\\HR_(optimal)= \$0.7305`

So the optimal Hedge Ratio is 0.7305.