Since the shares you own are on Gram Bank stock, you would like to use Gram Bank futures. Since there are no
futures available on the Gram Bank shares, you need to use futures on some related stock whose price changes are
highly correlated to the price changes of the Gram Bank shares. Among the Canara Bank futures and HDFC Bank
futures, the HDFC Bank futures have a higher correlation and hence HDFC Bank futures will be used for the hedge.
To decide how many contracts are to be used, we rst need to calculate the hedge ratio (h*):
h* = r ×
s
s
S
F
= 0.95 ×
22
145
= 0.1441
Number of futures contracts = N* = h* × ...
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