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

An airline hedges an exposure of 2 million gallons of jet fuel with heating oil futures, where each contract covers 42,000 gallons. The minimum variance hedge ratio is 0.70. Approximately how many contracts should the airline buy (long)?

The airline should buy about 33 contracts. Multiply the hedge ratio 0.70 by 2 million gallons to get 1.4 million gallons, then divide by 42,000 gallons per contract, giving roughly 33.3. Ignoring the hedge ratio would suggest about 48 contracts.

  1. A33Correct
  2. B67
  3. C48
  4. D27

Explanation

N* = h* x Q_A / Q_F = 0.70 x 2,000,000 / 42,000 = 1,400,000 / 42,000 = 33.3, so about 33 contracts. Without the hedge ratio the answer would be 47.6, about 48.

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