XYZ corporation would like to buy 15,000 units of commodity A after 1 year and wants to hedge the price risk using futures contracts. Unfortunately, there are no futures contracts on commodity A. Therefore, the company decides to buy futures contracts on commodity B which is similar to commodity A. The standard deviation of monthly changes in the price of commodity A is $2.2. The standard deviation of monthly changes in a futures price on commodity B $2.7. The correlation between the futures price and commodity A price is 0.75.

Each futures contract on commodity B is for delivery of 2,500 units of the product. At the time of entering the futures contract, the futures price was $12. At the time of closing the futures contract, the futures price is $13 and the spot price of commodity A is $14. What is the effective price paid for one unit of commodity A after taking into account the profit or loss on the futures contract? (Assume that the correct number of futures contracts are bought. The number of contracts to buy is rounded to the nearest integer. Round down decimals less than 0.5 and round up for 0.5 or more)

Select one:

a.  $12.23

b.  $12.57

c.  $12.83

d.  $13.13

e.  $13.33

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Solution Standard Deviation of monthly change in ... View the full answer