FRM Part I · FRM Exam Part I · Using Futures for Hedging
A refiner wants to hedge changes in the price of jet fuel using heating oil futures. The standard deviation of monthly changes in the jet fuel spot price is 0.040 and the standard deviation of monthly changes in the heating oil futures price is 0.050. The correlation between the two is 0.85. What is the minimum variance hedge ratio?
The minimum variance hedge ratio equals the correlation times the ratio of spot volatility to futures volatility. Here that is 0.85 multiplied by 0.040 divided by 0.050, which gives 0.68. Inverting the volatility ratio would wrongly give 1.06.
- A0.68Correct
- B0.85
- C1.06
- D0.72
Explanation
The minimum variance hedge ratio is h* = rho x (sigma_S / sigma_F) = 0.85 x (0.040 / 0.050) = 0.85 x 0.80 = 0.68. Option 1.06 inverts the volatility ratio (0.85 x 1.25). Option 0.85 ignores the volatility ratio.
Did you get it right without looking?
One question tells you little. A timed set on Using Futures for Hedging shows your real accuracy, how long you take and where you lose marks.
More Using Futures for Hedging questions
- A fund holds a $40 million equity portfolio with a beta of 0.90. The index futures price is 4,000 and the multiplier is $50. The manager wan…
- 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.…
- A jewelry manufacturer expects to buy gold in three months and wants to remove the risk of a price rise. Which futures position is appropria…
- A jewelry manufacturer expects to buy gold in three months and wants to protect against a rise in the price. Which futures position is appro…
- Which statement about hedging an equity portfolio with stock index futures is correct?
- A firm wants to hedge a spot exposure of 2,000,000 barrels of crude oil for one year using futures with a minimum-variance hedge ratio of 0.…