Financial Risk Manager Part 1

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Explanation:

The optimal hedge ratio is calculated as:

\text{HR} = \rho \times \left( \frac{\sigma_S}{\sigma_F} \right)

Where:

$\sigma_S$ is the standard deviation of the prices of the hedge asset (plastic spot price = 0.019)
$\sigma_F$ is the standard deviation of the prices of futures asset (rubber futures price = 0.032)
$\rho$ is the correlation coefficient between $\sigma_S$ and $\sigma_F$ (0.87)

\text{HR} = 0.87 \times \left( \frac{0.019}{0.032} \right) = 0.516 \approx 0.52

Note: The contract size of 45 tons and the exposure of 10 million tons are not directly used in computing the optimal hedge ratio itself, but would be needed to calculate the number of contracts. The optimal hedge ratio only depends on the ratio of standard deviations and their correlation.

Explanation:

The optimal hedge ratio is calculated as:

\text{HR} = \rho \times \left( \frac{\sigma_S}{\sigma_F} \right)

Where:

$\sigma_S$ is the standard deviation of the prices of the hedge asset (plastic spot price = 0.019)
$\sigma_F$ is the standard deviation of the prices of futures asset (rubber futures price = 0.032)
$\rho$ is the correlation coefficient between $\sigma_S$ and $\sigma_F$ (0.87)

\text{HR} = 0.87 \times \left( \frac{0.019}{0.032} \right) = 0.516 \approx 0.52

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Q.635 EmanueI is a junior trader working in the derivatives and hedging unit of a brokerage firm. EmanueI's superior instructed him to take a hedged position for one of its clients who wants to hedge its exposure in 10 million tons of plastic. Since the underlying asset is plastic and difficult to find futures contracts with the underlying asset of plastic, the trader is advised to take a position in rubber futures contracts. The contract size of rubber is 45 tons. If the standard deviation of the spot prices of plastic is 0.019, the standard deviation of the futures prices of rubber is 0.032, and the correlation coefficient between the two is 0.87, then determine what should be the optimal hedge ratio.

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Last updated: July 21, 2026 at 02:10

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