Price changes of two gold-mining stocks have shown strong positive correlation. Their historical relationship is Average percentage change in A .001 .75 1percentage change in B2 Changes in B explain 60% of the variation of the changes in A ( R 2 .6).

a. Suppose you own $100,000 of A. How much of B should you sell to minimize the risk of your net position?

b. What is the hedge ratio?

c. Here is the historical relationship between stock A and gold prices.

Average percentage change in A 2.002 1.2 1percentage change in gold price 2 If R 2 .5, can you lower the risk of your net position by hedging with gold (or gold futures) rather than with stock B? Explain.AppendixLO1

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TABLE 26.5 Spot prices for selected commodities and financial assets. See Problem 29. Asset Magnoosium Oat bran Spot Price Comments $2,800 per ton $.44 per bushel Biotech stock index Allen Wrench Co. 140.2 $58.00 Net convenience yield = 4% per year Net convenience yield = .5% per month Dividend = 0 Cash dividend = $2.4 per year common stock 5-year Treasury note 108.93 8% coupon Westonian ruple 3.1 ruples = $1 12% interest rate in ruples