Question: 1. Question 1 [Total: 20 marks] a) Consider the derivation of the optimal hedge ratio in the context of cross hedging. Please define the formula

1. Question 1 [Total: 20 marks] a) Consider the derivation of the optimal hedge ratio in the context of cross hedging. Please define the formula denoting the total variance of the component AS - hAF and define the components of the equation in words. [5 marks] b) Express graphically the total variance defined in part a) as a function of the hedge ratio h. Please label the axes and specify on the graph the point, where h* (optimal hedge ratio) is located. [ 5 marks] c) "If there is no basis risk the minimum variance hedge ratio is always 1". Is this statement true or false? Explain your answer in brief. [10 marks]

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