Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
- Suppose that the standard deviation of quarterly changes in the prices of a commodity is $0.65, the standard deviation of quarterly changes in a futures price on the commodity is $0.81, and the coefficient of correlation between the two changes is 0.8. What is the optimal hedge ratio for a three-month contract? What does it mean?
Explain what is meant by basis risk when futures contracts are used for hedging.
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