1) Assume it is October 2017 and United needs to purchase 10,000 K units of Jet Fuel 10 months from now in August 2018. United requires that any futures contract used to hedge have ample liquidity (where open interest is >= 100). Interest in futures contracts remains constant over time (e.g. in 3 months, the open interest in the April 2018 Heating Oil contract is 250, not 200). If United would prefer to avoid a stack and roll future procedure, what would be United’s best course of action? HINT: Think carefully about correlation. Cross Hedging, Optimal Hedge Ratio, Hedge Effectiveness= Correal^2.
A) Using 1386 October ‘18 crude oil contracts, United could effectively hedge 75.0% of the risk
B) Using 1386 October ‘18 crude oil contracts, United could effectively hedge 86.6% of the risk
C) Using 541 October ‘18 crude oil contracts, United could effectively hedge 86.6% of the risk
D) Using 223 October ‘18 heating oil contracts, United could effectively hedge 83.7% of the risk
E) Using 500 October ‘18 jet fuel futures, United could effectively hedge 100.0% of the risk
2) Assume it is October 2017 and United needs to purchase 10,000 K units of Jet Fuel 10 months from now in August 2018. United requires that any futures contract used to hedge have ample liquidity (where open interest is >= 100). Interest in futures contracts remains constant over time (e.g. in 3 months, the open interest in the April 2018 Heating Oil contract is 250, not 200). Given that United would prefer to avoid cross hedging, what would be United’s best course of action? HINT: Think carefully about Choice of Contract. Stack and Roll.
A) Hedge with October ‘18 heating oil contracts
B) Hedge with October ’18 crude oil contracts
C) Hedge with October ’18 jet fuel contracts
D) Hedge with 3 month jet fuel contracts, closing each set of contracts every 2 months out and simultaneously entering a new set of 3 month contracts through August 2018
E) Hedge with 6 month jet fuel contracts, closing the first set of contracts out in March 2018 and simultaneously entering a second set of 6 month contracts for September 2018.