Explanation:
The optimal hedge ratio (h*) is calculated using the formula: h* = Correlation × (Standard deviation of asset price change / Standard deviation of futures price change) h* = 0.80 × (75 / 84) = 0.7142857 ≈ 0.7143.
Q.12 Suppose that the standard deviation of semiannual changes in an asset price is 75 cents, and the standard deviation of semiannual changes in the futures price of a related asset is 84 cents. If the correlation between the two changes is 0.80, what is the optimal hedge ratio for a six-month hedge?
A
0.9375.
B
0.7143.
C
0.8960.
D
1.050.
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