Explanation

The optimal hedge ratio is calculated using the formula:

$h = \rho \times \frac{\sigma_s}{\sigma_h}$

Where:

• $\rho$ = correlation coefficient = 0.8
• $\sigma_s$ = standard deviation of spot jet fuel prices
• $\sigma_h$ = standard deviation of heating oil futures prices

Step 1: Calculate standard deviations

• $\sigma_s = \sqrt{0.0016} = 0.04$
• $\sigma_h = \sqrt{0.0009} = 0.03$

Step 2: Apply the formula $h = 0.8 \times \frac{0.04}{0.03} = 0.8 \times 1.333 = 1.067 \approx 1.07$

Why other options are incorrect:

• A (0.60): This results from reversing the standard deviations in the formula
• C (1.33): This is just the ratio of standard deviations without multiplying by the correlation
• D (1.42): This uses the variances directly instead of standard deviations