You are a futures trader on Lean Hog at Kantar, New York. You have the following information on Lean Hog. The standard deviation of monthly changes in the spot price of Lean Hog Futures is (in cents per pound) 5. The standard deviation of monthly changes in the futures price of Lean Hog Futures the closest contract is 8. The correlation between the futures price changes and the spot price changes is 0.8. It is now December 17, 2019. Your client, a pork producer, is committed to purchasing 400,000 pounds of lean hog on January 15. The producer wants to use February Lean Hog futures contracts to hedge its risk. Each contract is for the delivery of 40,000 pounds of cattle. a. What is the optimal hedge ratio? (sample answer: 0.45 or 45%) b. Should the pork producer take a long or short hedge? (sample answer: short or long) c. How many contracts of lean hog futures does your client need to take to hedge the risk?
You are a futures trader on Lean Hog at Kantar, New York. You have the following information on Lean Hog. The standard deviation of monthly changes in the spot price of Lean Hog Futures is (in cents per pound) 5. The standard deviation of monthly changes in the futures price of Lean Hog Futures the closest contract is 8. The correlation between the futures price changes and the spot price changes is 0.8. It is now December 17, 2019. Your client, a pork producer, is committed to purchasing 400,000 pounds of lean hog on January 15. The producer wants to use February Lean Hog futures contracts to hedge its risk. Each contract is for the delivery of 40,000 pounds of cattle.
a. What is the optimal hedge ratio? (sample answer: 0.45 or 45%)
b. Should the pork producer take a long or short hedge? (sample answer: short or long)
c. How many contracts of lean hog futures does your client need to take to hedge the risk? (sample answer: 6 contracts)
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