BOSTON COLLEGE

Department of Economics

EC 362
Financial Markets
Prof. Baum
Fall 1997

PROBLEM SET TWO

Due Wednesday, 15 October 1997, at classtime

Enclosed are monthly data for 1986-1990 on the CME British Pound contract. Using these data, answer the following questions. You may use any appropriate software (StataQuest, Excel, DataDesk, StatView, etc.).

These data may be accessed via Netscape from the course home page,

http://fmwww.bc.edu/EC-C/F97/EC362.F97.html

Click on the " Data for PS2" link and "Save As..." to place in a file.

1) What is the variance in the spot price of £ for the 1986-1990 period?

(2) What is the variance of the futures price of £ for this period?

(3) What is the simple correlation between the two series? Does it appear to be large enough to generate a reliable hedge?

(4) Calculate the optimal hedge ratio for this period using ordinary least squares (OLS) regression. What is the coefficient of determination (R-squared) of this regression? What does it tell you?

(5) Calculate your gains or losses (in US $) from a spot position of £ 625,000, using the appropriate (integer) number of futures contracts over the period. (Ignore the fact that this would be a rolling hedge).

(6) How would the optimal hedge ratio change if you used only the data from 1989 to calculate the OHR? How reliable is this estimate?

These are beginning-of-month quotes, derived from daily data. The Yr Mo Da refer to the quote date. W is the weekday (1=Monday). The "Con" is the contract used to provide the futures quotation (generally the near contract). Spot £ and Fut £ are quotations in $/£.