Suppose a hedger purchases 20 barrels of oil at year 0 for $100. She plans to sell this oil in year 3. Since no forward contracts are available for with 3 years to maturity, the hedger must use successive contracts that mature after 6 months. The riskless rate is 3%, the proportional storage cost is 2%, and the convenience yield of oil is 7%. After starting the hedging process, the following spot prices of oil are realized in years 0.5 to 3.  S(0.5) = 99, S(1) = 108, S(1.5) = 110, S(2) = 91, S(2.5) = 103,  S(3)=85. Show explicitly the net cash flow of the hedger at the end of year 3 from the hedging activity as well as the original exposure.

Answer rating: 100% (QA)

To hedge the exposure the hedger will need to enter into a series of forward contracts At each 6month interval she will need to buy or sell the necessary amount of oil at the current forward price to ... View the full answer