Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Patek Philippe needs to buy 400 pounds of 18 karat gold for its ongoing business of making luxury wristwatches. The company plans to buy the

Patek Philippe needs to buy 400 pounds of 18 karat gold for its ongoing business of making luxury wristwatches. The company plans to buy the gold on the spot market six months from today and it wants to hedge its risk using 6-month gold futures. Todays gold futures price is $1,810 per ounce and the size of one futures contract is 100 troy ounces, which is 6.857 pounds. The underlying asset for the gold futures contract is 24 karat gold. A financial analyst at Patek Philippe has calculated a beta equal to 14.25. To calculate the beta, the analyst used a linear regression of 18 karat gold spot price changes per pound against gold futures price changes per troy ounce. The regression R-squared is 0.956. The company's target beta is zero. Should Patek Philippe go long or short to hedge? How many futures contracts should be used for cross-hedging? How much of the variance is eliminated by hedging? Note: question 2 involves cross-hedging since 24 karat gold and 18 karat gold are not perfectly correlated.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Bitcoin Technical Innovations From The Trenches

Authors: Sjors Provoost

1st Edition

9090360425, 978-9090360423

More Books

Students also viewed these Finance questions