Future and Forward Quiz 2

vaishnevis
Posts: 3
Joined: Sat May 13, 2017 8:15 am

Future and Forward Quiz 2

Postby vaishnevis » Sun Jun 25, 2017 4:10 am

Q 10.-A bronze producer will sell 1,000 mt (metric tons) of bronze in three months at the prevailing market price at that time. The standard deviation of the price of bronze over a three-month period is 2.6%. The company decides to use three-month futures on copper to hedge. The copper futures contract is for 25 mt of copper.
The standard deviation of the futures price is 3.2%. The correlation between three-month changes in the futures price and the price of bronze is 0.77. To hedge its price exposure, how many futures contracts should the company buy/sell?

Shouldnt correct answer be Sell 25 futures, as the producer is long asset, should short futures.
Answer provided in buy 25 futures. Please help in the logic.

edupristine
Finance Junkie
Posts: 798
Joined: Wed Apr 09, 2014 6:28 am

Re: Future and Forward Quiz 2

Postby edupristine » Fri Jul 21, 2017 9:43 am

Yes, the correct answer is sell 25 futures.
To hedge the exposure, the company should sell futures and not buy. Their profits will be adversely affected by declines in the price. The number of contracts to sell, N, equals (Beta x Size of the position)/Size of one futures contract.


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