HW2-AAEC4870-Spring17

5 problems 60 points total solve problems and

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5 PROBLEMS (60 points total) Solve problems and demonstrate your work rigorously. 21) (12p) A trader owns 55,000 units of a particular asset and decides to hedge the value of her position with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price of the asset that is owned is \$28 and the standard deviation of the change in this price over the life of the hedge is estimated to be 0.43. The futures price of the related asset is \$27 and the standard deviation of the change in this over the life of the hedge is 0.40. The coefficient of correlation between the spot price change and futures price change is 0.95. a) What is the minimum variance hedge ratio? b) Should the hedger take a long or short futures position? c) What is the optimal number of futures contracts with no tailing of the hedge? d) What is the optimal number of futures contracts with tailing of the hedge?

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6 22) (12p) Let’s assume you’re a soybean producer. In July, you decide to hedge the sale of a portion of your expected bean crop for delivery in the fall. Currently, November futures are trading at \$12.55 per bushel, and the quoted basis for harvest delivery today is 25 cents under November Soybean futures. According to your historical basis records, the local basis for harvest is normally 20 cents under the November Soybean futures contract. Fill out the blanks below by indicating actions (i.e. buy/sell etc.) as well as prices. a) Cash market Futures market Basis Jul ____________ ____________ ____________ b) What price will you receive for your harvest sale if the actual basis is as you expected? Sold Nov Expected Expected futures in July at: basis: selling price: ______________ ____________ ____________ c) By October, the local elevator price for soybeans has declined to \$11.90 per bushel. You sell your soybeans for that cash price, and you buy a futures contract at \$12.10 per bushel to offset your hedge. Bring down the information from the previous table and complete
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• Spring '17
• Karali
• Forward contract

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