Question

To minimize the basis risk, a company using the futures market to hedge the price risk should use a hedge ratio as close to 1 as possible.

T or F?

Answer #1

A hedge ratio is the ratio of exposure to a hedging instrument to the value of the hedged asset. A ratio of 1 or 100% means that the position is fully hedged and a ratio of 0 means it is not hedged at all.

Hedge ratio is an important statistic in risk management because it tells us the extent to which the risk of any adverse movement in our asset or liability will be met by any offsetting movement in the hedging instrument. As you will see in the example below, the hedge ratio changes due to changes in value of the hedging instrument and/or the hedged asset or liability.

So based on detail i given i can say above given statement is TRUE.....

An investor wants to minimize market risk on a $50 million stock
portfolio by using futures for hedging. The portfolio’s beta with
respect to the S&P 500 equity index is 1.25. The current index
futures quote is 2,875 and each contract is for delivery of $250
times the index.
a. What futures position should the investor open to execute the
hedge? Long or short?
b. How many index futures contracts does the investor need to
use to minimize market risk?...

Consider a cross hedge, for example using heating oil futures to
cross hedge the price risk of jet oil. Suppose the measure of hedge
effectiveness is 0.7. Which of the following is true?
A. It means that the optional amount of futures should be 70% of
the underlying assets to be hedged
B. It means that the uncertainty in the value of the hedged
portfolio is 70% lower than the uncertainty in the unhedged
portfolio
C. It means that the...

Your company deals with Allyom and wants to hedge
its risk using future contracts. However, Futures are not available
in Allyom. Closely correlated commodity is Gold in which future
contracts are available. You are provided with the following data.
Calculate the Optimal Hedge Ratio and Total Number of Gold Future
Contracts that your company should buy to hedge their
position.
Total Units of Allyom
65,000
Gold Future Contract Size
2,000
Day
Allyom Spot
Gold Future
0
1,200
1,220
1
1,207...

Your company deals with Alliance and wants to hedge
its risk using future contracts. However, Futures Contracts are not
available in Alliance. Closely correlated commodity is Gold in
which future contracts are available. You are provided with the
following data. Calculate the Optimal Hedge Ratio and Total Number
of Gold Future Contracts that your company should buy to hedge
their position.
Total Units of Alliance
75,000
Gold Future Contract Size
2,000
Day
Allyom Spot
Gold Future
0
1,200
1,220
1...

Which of the following decreases basis risk?
Greater similarity between the underlying asset of the futures
contract and the hedger’s exposure
A decrease in correlation coefficient between the underlying
asset of the futures contract and the hedger’s exposure
Hedge using the “stack and roll” of short-term futures
contracts
increase in the time between the date when the futures contract
is closed and its delivery month

Describe how to use futures contracts to hedge. Calculate the
profit or loss of using futures contract.

Mark is long GBP 100 million and
decides to use the futures market to hedge her portfolio rather
than enter into a forward contract. One contract is for
GBP 50,000. The current month contract is trading at 1.21
USD/GBP.
What is the USD notional value of one GBP futures
contract?
How many GBP contracts would be required to hedge the GBP 100
million portfolio?
Would she buy or sell the GBP contracts in order to hedge the
portfolio?
What are the...

Suppose that spot and futures prices of the underlying asset
when hedge is initiated are $26.50 and $24.20 respectively, and
when hedge is closed out are $25.00 and $24.99 respectively.which
one is true from the followings?
1.effective price paid = $24.21
2.Basis risk when hedge is closed out = $2.3
3.both 1 & 2
4.none of the above

You are a futures trader at Kantar Trading Company, New York.
You have the following information on Lean Hog. The standard
deviation of monthly changes in the spot price of Lean Hog Futures
is (in cents per pound) 5. The standard deviation of monthly
changes in the futures price of Lean Hog Futures the closest
contract is 8. The correlation between the futures price changes
and the spot price changes is 0.8. It is now December 17, 2019.
Your client,...

1. Back in May 2020, an ethanol plant’s risk manager looked at
futures prices and considered a hedge to lock in a price on part of
her new-crop corn acquisition planned for mid-to-late October 2020.
She saw that the December 2020 futures contract was trading at
$3.20/bushel and she knew that the basis in mid-October—when she
expected to take delivery of the corn in question and to lift the
hedge (i.e., to offset her futures position)—has typically (most
years) been...

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