A company of methanol, which uses natural gas as one of its inputs in production. The majority of the methanol
A company of methanol, which uses natural gas as one of its inputs in production. The majority of the methanol produced is sold to Europe - on average 80%. In the past year, their profits fluctuated significantly given changes in the price of gas. Their orders were booked when the price of gas was $3.43 per MMBTU, but since then prices increased. In addition, the US strengthened relative to the Euro. The sales department books sales of $130 million worth of methanol and 80% of orders are from Europe. The company estimates they will need 40 million standard cubic feet of gas by the end of the next four months to manufacture the methanol. Gas is quoted as $3.60 per MMBTU in the spot market and the US was trading at $1.55 to €1. Accordingly, the contract specification is as follows:
(1) Euro futures trading unit was €60,000;
(2) Gas futures trading unit was 20,000. The quoted gas futures price four months later is $3.45 per MMBTU.
a. What kind of hedging strategy should the company use to minimize their exposure to volatility in gas prices? Design a suitable hedge and show what would be the result if gas prices went to $3.50 per MMBTU at the end of four months when the company would be ordering gas.
b. What hedging strategies can the company use to minimize the impact of exchange rate volatility?
c. Using the information given for British Pound futures contracts, design a suitable hedge that would minimize the company's exposure to fluctuations in the exchange rate between the US dollar and the Euro. Explain the results of the hedge if by October, when payment is received from the European wholesalers, the exchange rate goes to $1.450 to €1?