29. Hedging (S27-7) Price changes of two gold-mining stocks have shown strong positive correlation.

Their historical relationship is Average percentage change in A = 0.001 + 0.75 ( percentage change in B )

Changes in B explain 60% of the variation of the changes in A (R2 = 0.6).

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 = − 0.002 + 1.2 ( percentage change in gold price )

If R2 = 0.5, can you lower the risk of your net position by hedging with gold (or gold futures) rather than with stock B? Explain.