Question

1. A cocoa merchant currently has a cocoa inventory worth approximately $10 million at current spot of $1840 per metric ton. Cocoa futures trade on the Coffee, Cocoa and Sugar Exchange with contract size equal to 10 metric tons. Current price for a May contract is $1630 per metric ton. She would like to hedge with a minimum variance hedge ratio, so she calculates some statistics. The standard deviation of returns for her inventory is .27. The measured volatility of the futures contract price is .33. The correlation between the spot cocoa and futures contract price is .85.

a. calculate the current number of metric tons in inventory based on the current price. Calculate the minimum variance hedge ratio and optimal number of contracts to hedge with.

b. Should she go short or long with her position? Explain.

Answer 1