1. Suppose a summer drought destroys much of this years wheat harvest. What would be your prediction for the change in the basis, F S?

2. Oil inventories are at record levels and oil is being stored in ever-more expensive facilities such as ships at sea. What is your prediction for the change in the basis, F S?

3. The interest rate has fallen to record lows. What is your prediction for the impact on the basis, F S?

4. Here are the results of a monthly index model of stock returns for FinCorp Stock:

r(Fincorp) = .001 + .8 r(S&P500) + e

The standard deviation of the monthly return on the S&P 500 was .05.

The standard deviation of the monthly value of the residual, e, was .03.

a. What was the variance of the return on FinCorp stock? Remember that e and the return on the S&P 500 are essentially uncorrelated.

b. What was the standard deviation of the return on FinCorp stock?

c. If you hold $2 million in FinCorp stock, how many 1-month S&P futures contracts must you sell to make your portfolio market neutral (zero beta) over the next month? The S&P index is currently at 2000, and the contract multiplier is $250.

d. What would be the standard deviation of your hedged position if you were to sell this number of S&P contracts?

e. What percentage reduction in the variance of your rate of return is achieved by your hedge? [Submit your answer as a percentage between 0 and 100.]