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An asset manager responsible for a portfolio of agricultural commodities expects to sell 1800kg of cotton within 1 month. Historical standard deviations of cotton spot price and cotton 1-month futures contract price are 0.04 and 0.07, respectively. Historical correlation between the cotton spot price and the 1- month cotton futures contract price is 0.78. Relevant characteristics of the 1- month cotton futures contract are: Contract Size: 180 kg; Initial Margin: 3150; Maintenance margin: 2450. Under the terms of the contract, the margin call is set to bring the margin account balance level to 6% above the initial margin. To answer the following questions, make plausible assumptions if necessary. Additionally, in case you prefer and when appliable, standard characters can be used (e.g. b rather than , capital_sigma rather than and sigma rather than ). a) The asset manager wants to use this futures contract for hedging purposes. Explain what a future contract is, what can be a possible reasoning for this asset manager wanting to use a future contract, and whether the position would be short or long in the contract. [20 marks] b) How many contracts should the asset manager use if he wants to hedge 35% of his risk exposure? (Round answer to zero decimal places: e.g., 7.8 to 8). Explain your answer. [20 marks] c) Complete in your answer book the following table (Table 1), explaining computations. If you didnt solve Question 1b, assume the number of futures contracts to be 2. (Note: if you prefer, instead of drawing a table you can answer as follows (example for Day 2): Day 2: Daily gain (loss) = ...; Margin account balance = ...; Margin Call = ...;)

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