Farmer D. Jones has a crop of grapefruit that will be ready for harvest and sale as
Question:
Farmer D. Jones has a crop of grapefruit that will be ready for harvest and sale as 150,000 pounds of grapefruit juice in 3 months. Jones is worried about possible price changes, so he is considering hedging. There is no futures contract for grapefruit juice, but there is a futures contract for orange juice. His son, Gavin, recently studied minimum-variance hedging and suggests it as a possible approach. Currently the spot prices are \(\$ 1.20\) per pound for orange juice and \(\$ 1.50\) per pound for grapefruit juice. The standard deviation of the prices of orange juice and grapefruit juice is about \(20 \%\) per year, and the correlation coefficient between them is about .7. What is the minimum-variance hedge for farmer Jones, and how effective is this hedge as compared to no hedge?
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