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Actual exam question for
PRMIA's
Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP – 2015 Edition exam

Question #: 28

Topic #: 1

[All Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP – 2015 Edition Questions]
Topic #: 1

An asset has a volatility of 10% per year. An investment manager chooses to hedge it with another asset that has a volatility of 9% per year and a correlation of 0.9. Calculate the hedge ratio.

The minimum variance hedge ratio answers the question of how much of the hedge to buy to hedge a given position. It minimizes the combined volatility of the primary and the hedge position. The minimum variance hedge ratio is given by the expression [ (x) / (y) ] * (x,y)]. Effectively, this is the same as the beta of the primary position with respect to the hedge.

In this case, the hedge ratio is = 10%/9% * 0.9 = 1

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