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FRM Part I · FRM Exam Part I · Using Futures for Hedging

A hedger's spot position and futures position have a correlation of 0.90 between price changes. The standard deviation of spot changes is 0.20 and of futures changes is 0.25. What is the minimum variance hedge ratio?

The minimum variance hedge ratio is 0.72. It equals the correlation of 0.90 multiplied by the ratio of spot volatility to futures volatility, 0.20 divided by 0.25, which is 0.80.

  1. A0.72Correct
  2. B0.81
  3. C0.90
  4. D1.11

Explanation

h* = ρ × σS/σF = 0.90 × 0.20/0.25 = 0.90 × 0.80 = 0.72. Using 0.81 would square the correlation, and 1.11 inverts the volatility ratio.

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