A soybean dealer has a current inventory of 1 million bushels of beans. She is concerned because lately bean prices have both been drifting downward and increasing in volatility. Thus, she decides to hedge her inventory. She looks at the last 60 days of daily price data and puts spot and futures price data into the following equation:

DC_t = a+bDF_t + e_t

where C is the daily spot (cash) price and F the daily futures price.

The estimation yields the following: a = 0.6976, b = 0.8713, R² = .56.

Based on the results above, what is the optimal hedge ratio?

Using the data in (a), what is the optimal number of contracts to hedge with if each contract is for 5,000 bushels of beans?

Should she use a short or long hedge? Explain.

The price of beans when the hedge was put into place was $4.05 a bushel and the futures price was $4.62 a bushel. When the hedge was lifted, bean prices were $2.49 and the futures price was $3.62.

Evaluate the gains or losses on the spot and futures position.

Compare the size of the spot change to the size of the futures change. How

close to R² was it?