Problem
The standard deviation of monthly changes to the spot price of live cattle is 2.5 cents per kg. The standard deviation of monthly changes to the futures price of December live cattle contracts is 3.0 cents per kg and the correlation between spot and futures price changes is 0.72. It is now September 14"". A beef producer needs to sell 100,000 kg of live cattle on November 14m. and wants to use December futures to hedge its risk. The current spot price is 125 cents per kg and December futures are trading for 128 cents per kg. Each contract is for 10,000 kg of live cattle.
1. What strategy should the beef producer follow?
2. If on November 14'h the spot and December futures price was 115 centsIkg and 116 cents/kg respectively, and on 14'11 December both the spot and December futures prices were 1 10 cents/kg. what is the effective price that the producer will receive?