Question # 4

Suppose that standard deviation of monthly changes in spot prices of live cattle is 1.2 cents per pound of live cattle, and the standard deviation of monthly changes in futures prices or the closing contracts is 1.4 cents per pound of live cattle. The coefficient of correlation between the two changes is 0.8. If a food processing company wants to hedge 500,000 pounds of live cattle and the size of the relevant futures contract on live cattle is 45,000 pounds then

(1) What strategy should a beef producer (user of live cattle) follow? What does it mean?

(2) What is the optimal number of futures contract with no tailing of the hedge?

(3) What is the optimal number of future contract with tailing of the hedge?