On 3rd March 2020, Anuj, a Delhi based gold jeweller buys 12 kgs. of gold in the cash market as a raw material to make jewellery from it. Anuj wants to protect himself from a decline in the prices of gold till the jewell

CS Professional · Capital Commodity and Money Market · PYQS · June 2021
On 3rd March 2020, Anuj, a Delhi based gold jeweller buys 12 kgs. of gold in the cash market as a raw material to make jewellery from it. Anuj wants to protect himself from a decline in the prices of gold till the jewellery is ready for sale in 45 days. He decides to hedge by selling futures contract of gold. The standard deviations of the change in the cash price of gold and change in futures price of gold over the last 45 day period is 0.88 and 0.60 respectively. The coefficient of correlation between the change in cash price and the futures price of gold for 45 days is 0.87. Standardised futures contract size of gold is 1 kg. (ii) How much gold futures contracts should be sold by Anuj ?

Answer & Explanation:

(ii) How much gold futures contracts should be sold by Anuj? To determine the number of futures contracts to sell, we use the Optimal Hedge Ratio calculated in part (i). Optimal Hedge Ratio (h) = 1.276 Quantity of gold to be hedged = 12 kgs. Standardised futures contract size = 1 kg. Number of futures contracts to sell = (Optimal Hedge Ratio * Quantity of gold to be hedged) / Futures contract size Number of futures contracts = (1.276 * 12 kgs) / 1 kg = 15.312 contracts Since futures contracts are typically traded in whole numbers, Anuj should sell 15 (rounded off) gold futures contracts to hedge the physical exposure of 12 kg. of gold.

Topics: Commodity Market

Open in Interactive Practice Hub · Full Practice Hub · Chapter Weightage · More in this subject

Related Questions in this Topic