Answer-first summary for fast verification
Answer: Futures on Commodity A with 9 months to expiration
## Explanation To minimize basis risk when hedging with futures contracts on correlated commodities, we need to consider two key factors: 1. **Correlation with the underlying asset**: Higher correlation reduces basis risk 2. **Matching the hedge duration**: The futures contract expiration should match or be close to the hedging period **Analysis:** - **Correlation**: Commodity B has a higher correlation (0.92) with plastic prices than Commodity A (0.85), making Commodity B futures more effective for hedging plastic price exposure - **Hedging period**: 7.5 months - **Available contracts**: 6-month and 9-month expirations **Basis risk minimization**: - The 9-month contract is closer to the 7.5-month hedging period than the 6-month contract - Higher correlation (Commodity B) combined with better duration matching (9-month contract) will minimize basis risk **Therefore, the best contract to minimize basis risk would be Futures on Commodity B with 9 months to expiration** (though this option isn't explicitly listed in the provided choices, based on the correlation data, Commodity B with 9-month expiration would be optimal). However, since the question only provides options for Commodity A, and given that the 9-month contract better matches the 7.5-month hedging period than the 6-month contract, **Option B (Futures on Commodity A with 9 months to expiration)** would be the better choice among the given options.
Author: LeetQuiz .
Ultimate access to all questions.
Pear, Inc. is a manufacturer that is heavily dependent on plastic parts shipped from Malaysia. Pear wants to hedge its exposure to plastic price shocks over the next 7 ½ months. Futures contracts, however, are not readily available for plastic. After some research, Pear identifies futures contracts on other commodities whose prices are closely correlated to plastic prices. Futures on Commodity A have a correlation of 0.85 with the price of plastic, and futures on Commodity B have a correlation of 0.92 with the price of plastic. Futures on both Commodity A and Commodity B are available with 6-month and 9-month expirations. Ignoring liquidity considerations, which contract would be the best to minimize basis risk?
A
Futures on Commodity A with 6 months to expiration
B
Futures on Commodity A with 9 months to expiration
No comments yet.