Question: 1. A refiner, for the next two months, has exposure to 3.562 million gallons of ethanol for mixture with gasoline to create a blended fuel. Ethanol is traded on the NYNEX with contract size specifications of 29.000 gallons for each contract. The standard deviations for ethanol and futures contracts on ethanol arc .72 and .82 respectively while the correlation coefficient is .75. What would be the optimal number of contracts for the refiner to hedge with?
2. If the spot and futures prices for ethanol in the question above are 1.898 and 1.927 respectively, how many contracts should be used to hedge the exposure in the problem above if you tail the hedge?