QUESTION 1

Use the information in the table below to help design an appropriate hedging strategy for Lunar Airlines Ltd under the following conditions:

Estimated fuel cost on June 2018	504,000
Jet fuel spot price	1.80/gallon
6-month heating oil futures price	1.94/gallon
Size of heating oil contract	4,000 gallons
Standard deviation of past jet fuel prices	0.032
Standard deviation of past heating oil prices	0.026
Correlation between jet fuel and heating oil prices	0.93

1. 1.1 Calculate the optimal number of future contract required to help Lunar Airlines hedge against jet fuel price risk, if the only available contracts are those on heating oil futures. Calculate the number of contracts required when you assume both tailing and no tailing conditions.

   (15 %)

2. 1.2 Show the position of Lunar Airlines Ltd's fuel oil costs with no daily settlement, assuming the price of jet fuel increases to 2.10/gallon in 6 months while heating oil prices increased to 2.20/gallon in the same period. Briefly discuss your answer indicating

whether you think the hedging strategy was a success or a failure?

1.3 Discuss the ways a future contract differs from a forward contract?