2. Your company produces 50,000 units of a particular asset and decides to hedge the value of

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 $21 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 $19 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 is 0.85.

a) What is the minimum variance hedge ratio (Optimal)?

b) Should the hedger take a long or short futures position? Why?

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?

e) For some reason if correlation change to 0.9 and all the above data remains same, will the number of contracts in c) and d) increase or decrease? Why? (no need for calculations, just write one or two lines)