An airline knows it will need to purchase fuel for its future operations and wishes to hedge
Question:
An airline knows it will need to purchase fuel for its future operations and wishes to hedge 75% of its purchases for 3 years using forward contracts.
The airline estimates it will need to purchase the amount of fuel on the dates shown in the table below:
| 1 July 2021 | 1 July 2022 | 1 July 2023 | 1 July 2024 |
Fuel to be purchased (metric tonnes) |
1,980,000 |
2,000,000 |
2,200,000 |
2,400,000 |
(iv) Determine the number of hedging contracts it should purchase on 1 July 2021 for delivery on these dates. Clearly state your assumption(s). [4 marks]
It turns out that the spot price at expiry is as shown below.
1 July 2021 | 1 July 2022 | 1 July 2023 | 1 July 2024 | |
Spot price (US dollars) | 600 | 610 | 580 | 650 |
Risk-free rate on US government bonds (p.a.) | – | 1.20% | 1.30% | 1.50%
|
The risk-free rate on US government bonds is continuously compounded.
(v) Calculate the profit or loss at the expiry of the contracts compared with the case in which the airline had not hedged its fuel requirements. Clearly state your assumption(s). [6 marks]
(vi) Comment on the advantages and disadvantages of the airline’s hedging policy. Suggest an improvement to the above strategy. [5 marks]
Expert Answer:
iv Determine the number of hedging contracts it should purchase on 1 July 2021 for delivery on these dates Clearly state your assumptions Answer The a... View the full answer
Data Analysis and Decision Making
ISBN: 978-0538476126
4th edition
Authors: Christian Albright, Wayne Winston, Christopher Zappe
