A firm owns an asset A and it wants to hedge against changes in the value of A by making an offsetting sale of asset B. The firm minimizes risk if:
A) Selling the same number of units of B as assets of A
B) Selling hedge ratio (delta) number of units of B
C) Selling the reciprocal of hedge ratio number of units of B
D) None of the above

Question

Quizplus · Accepted Answer

The hedge ratio (delta) is the ratio of the change in the value of asset B to the change in the value of asset A. By selling this ratio number of units of B, the firm can fully offset any changes in the value of A with changes in the value of B, minimizing its risk. Therefore, selling the hedge ratio number of units of B is the best choice.

A Firm Owns an Asset a and It Wants to Hedge