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What is the optimal hedge ratio

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A company will lose $50,000 for each 1 cent decrease in the price per gallon of jet fuel over the next two months. The company plans to hedge its exposure to jet fuel with heating oil futures. Jet fuel price changes have a 0.7 correlation with heating oil futures price changes. Jet fuel price changes have a standard deviation of $3 and price changes in heating oil futures have a standard deviation of $2. Each futures contract is on 25,000 gallons.

a) What is the optimal hedge ratio? What does this hedger ratio mean?

b) What is the company's exposure measured in gallons of the new fuel?

c) What position measured in gallons should the company take in heating oil futures?

d) How many heating oil futures should be traded?

e) Should the company take long or short futures positions? Why?

Reference no: EM132611764

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