FRM Part I · FRM Exam Part I · Using Futures for Hedging
An airline hedges jet fuel with futures on a related crude oil contract. The spot price of jet fuel changes with standard deviation 0.040 per period, the futures price changes with standard deviation 0.050, and the correlation between the changes is 0.80. What is the minimum-variance hedge ratio?
The minimum-variance hedge ratio is 0.64. It equals the correlation of 0.80 multiplied by the ratio of spot to futures volatility, 0.040 divided by 0.050, which is 0.80, giving 0.64 futures units per unit of exposure.
- A0.64Correct
- B0.80
- C1.00
- D0.50
Explanation
h* = rho x (sigma_S / sigma_F) = 0.80 x (0.040/0.050) = 0.80 x 0.80 = 0.64. A distractor of 0.80 ignores the volatility ratio.
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