FRM Part I · FRM Exam Part I · Using Futures for Hedging
An airline will buy 1,000,000 gallons of jet fuel and hedges with heating oil futures. Estimated changes: standard deviation of jet fuel price changes is 0.030, of futures price changes is 0.040, and their correlation is 0.80. One contract covers 42,000 gallons. What is the number of contracts to buy (nearest whole number) using the minimum variance hedge ratio?
The minimum variance hedge ratio is 0.60, so about 600,000 gallons should be hedged, which is roughly 14 contracts at 42,000 gallons each.
- A19Correct
- B24
- C30
- D36
Explanation
h* = 0.80 × 0.030/0.040 = 0.60. Optimal futures exposure = 0.60 × 1,000,000 = 600,000 gallons. Contracts = 600,000/42,000 = 14.29, about 14. Checking: the options do not include 14, so recompute carefully: 14.29 rounds to 14, which means the stated key is wrong.
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