Answer and Explanation:
Given that correlation between the monthly changes of the spot price and futures price of a commodity = 0.95
standard deviations of monthly changes of the spot price = 0.25
standard deviations of monthly changes of the futures price = 0.30
Futures contract =1000 units of commodity
To calculate how many futures contracts long or short if company needs to purchase 50,000 units of the commodity in 1 month using the futures contract hedge the price risk:
We calculate Hedge ratio = correlation * Spot price changes Standard deviation/ Futures contract price changes standard deviation
= 0.95 * 0.25/0.30
=0.7917
=79.17%
Calculate how many futures contracts the company should short =
50000 * 79.17%/1000
=39.58
= -39 contracts(negative shorts as from question)
