American Airlines believes that it will need to buy 840,000 gallons of jet fuel in 3...

Transcribed Image Text:

American Airlines believes that it will need to buy 840,000 gallons of jet fuel in 3 months. The standard deviation of the change in price per gallon of jet fuel over a-3 month period is calculated as 0.032. The company chooses to hedge by taking a position in futures contracts on heating oil. The standard deviation of the change in the futures price over a 3-month period is 0.040. The coefficient of correlation between the 3-month change in the price of jet fuel and the 3-month change in the futures price is 0.8. One heating oil futures contract is on 42,000 gallons. 1. What type of hedger should American be - long or short? 2. What is the minimum variance hedge ratio? 3. How many futures contracts should they use to obtain the minimum variance hedge ratio? 4. What could happen to jeopardize this hedge? What is this risk called? American Airlines believes that it will need to buy 840,000 gallons of jet fuel in 3 months. The standard deviation of the change in price per gallon of jet fuel over a-3 month period is calculated as 0.032. The company chooses to hedge by taking a position in futures contracts on heating oil. The standard deviation of the change in the futures price over a 3-month period is 0.040. The coefficient of correlation between the 3-month change in the price of jet fuel and the 3-month change in the futures price is 0.8. One heating oil futures contract is on 42,000 gallons. 1. What type of hedger should American be - long or short? 2. What is the minimum variance hedge ratio? 3. How many futures contracts should they use to obtain the minimum variance hedge ratio? 4. What could happen to jeopardize this hedge? What is this risk called?

Answer rating: 100% (QA)

1 American should be a long hedger meaning that they are buying futures contract... View the full answer