Question 2. It is January 31, 2019. A local brewery is a large producer of craft beer whose main ingredient is barley. The demand for craft beer is seasonal with the largest demand occurring mid-June through the end of August. Production schedules require the acquisition of 80 metric tons (MT) of barley in late May to meet the summer season demand. The management of the brewery is concerned about the possibility that a rise in the price of barley between now and the end of May could hurt profit margin. Barley must be acquired for $350 per metric ton (MT) or less to ensure profitability. On February 1, 2021, the ICE June 2021 Barley futures contract (20 MT per contract) is selling for $351.80 per MT. The standard deviation of the change in the spot price of barley is 0.80. The standard deviation of the change in the futures price of barley is 0.56. The correlation between the change in futures price and the change in spot price is 0.60. One contract of barley is 20 metric tons on ICE.

1. Determine the hedge effectiveness and comment. Determine and discuss the effects of the hedge effectiveness of (i) a 25% decline in the correlation between the changes in futures price and the change in sport price, r, (i) a doubling of the standard deviation of the change in the spot price of barley, s_s, and (iii) a doubling of the standard deviation of the change in the futures price of barley, s_F?