Exercise i (Wk3/4) Suppose that the 1-year forward corn price is $2.50/bu and that there are 4 equally likely states abo

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Exercise I Wk3 4 Suppose That The 1 Year Forward Corn Price Is 2 50 Bu And That There Are 4 Equally Likely States Abo 1 (43.74 KiB) Viewed 21 times

Exercise i (Wk3/4) Suppose that the 1-year forward corn price is $2.50/bu and that there are 4 equally likely states about the corn production and the corn price in 1 year. The four states are summarized in the following table. State Probability Corn Production Fixed Cost Variable Cost Corn Price (5) 1 25% 1.5m $0.0 $0.5/bu $2.0/bu 2 25% 1.5m $0.0 $0.5/bu $2.5/bu 3 25% 1.0m $0.0 $0.5/bu $2.5/bu 4 25% 1.0m $0.0 $0.5/bu $3.0/bu mean 2.5 (a) Derive the variance-minimizing hedge quantity formula and find the quantity of forward contracts that minimize the variability of net income. (b) Comparing the standard deviations of the total net income with and without hedging, compute how much the variability of the net income is reduced by adopting the optimal hedging strategy.