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1. A food processing company knows that it will buy 1 million bushels of corn in three months. The standard deviation of the change in the price per b of bushel over a 3-month period is calculaed 0.055 (5.5%). The company chooses to hedge by buying futures contracts on corn. The sandard deviation of the change in the futures price over 3-month period is 0.065 (6.5%) and the coefficient of correlation between the 3-month change in the price of corn and 3-month change in the futures price is 0.75.

a. What is the optimal hedge ratio?

b. One Corn contract is 50,000 bushels. How many contracts should the company entered?

2. Today's Dec 2010 Ethanol settlement price was $1.97 per gallon. Suppose that when the contract matures in December, the price of Ethanol turns out to be $2.07 per gallon.

a. What will be the profit or loss be for the long position trader who entered the contract at the futures price?

b. If each contract calls for delivery of 29,000 gallons what would the dollar profit / loss be to the long position trader?

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