Explanation:
The definition of cross-hedging provided by Melanie Gomez is incorrect, while the definition of tailing the hedge is correct.
Cross-hedging, by definition, involves using a related but not identical asset to hedge against price risk. If the hedging instrument is identical to the underlying asset being hedged, it is not considered cross-hedging but rather a straightforward hedging strategy.
Tailing the hedge is a process conducted by analysts while hedging with futures contracts. It is the process of calculating the correlation between the percentage of one-day changes in the futures and spot prices in order to estimate the number of contracts needed to hedge over the next day. Melanie's definition of this concept is accurate.
Choice A is incorrect. While it correctly identifies that Statement I is incorrect, it incorrectly asserts that Statement II is also incorrect.
Choice C is incorrect. This choice incorrectly asserts that both statements are correct. The definition provided for cross-hedging in Statement I is inaccurate.
Choice D is incorrect. While it correctly identifies that Statement I's definition of cross-hedging is wrong, it inaccurately claims that the definition of tailing the hedge provided in Statement II is also wrong. Tailing the hedge indeed involves determining the correlation between percentage changes in futures and spot prices to estimate future hedging requirements.
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Q.637 Melanie Gomez is a former trader and the anchor of a local business TV channel. She is famous for her analysis and forecasts of commodities prices. She also presents a weekly education program to educate beginner traders on complex derivatives instruments and hedging strategies. She made the following definitions of some jargons used for hedging in her TV program:
I. Cross-hedging occurs when two offsetting positions are opened in futures contracts with identical underlying assets.
II. Tailing the hedge is a process of calculating the correlation between percentage one-day changes on the futures and spot prices to estimate the number of contracts needed to hedge over the next day.
Which of the following is correct?
A
Statement I is correct while statement II is incorrect.
B
Statement I is incorrect while statement II is correct.
C
Statement I is correct and statement II is also correct.
D
Statement I is incorrect and statement II is also incorrect.