Small businesses or corporations with little knowledge or exposure to factors affecting underlying asset prices. Example: Starbucks hedging its energy exposure.
Airline Example – Jet Fuel Hedging when competitors don’t… Discuss example of power utility or Oil producer. The decision to hedge and if so how much (%) and how far forward (Yrs) Are there any natural hedges for these examples? Exelon & Sunoco for example.
Discuss Contango vs. Backwardation nearby vs. forward futures In graph above, futures may actually fall below spot between t1 & t2 – basis can be volatile What factors could affect this? 1) Shortage of physical commodity (inverts) 2) interest rates rising (widens)
Note: Storage may not be available – what typically happens to basis then? – basis increases – futures move higher than spot Other reason for basis – expected quality difference of product likely to be delivered to exchange – Oil with sulfur content
Can there be basis at futures expiration? Discuss how – Quality difference at settlement – delivery costs – because contracts typically require seller to have product delivered to exchange approved location.
This also works for hedging individual stock positions, but the hedges performance is considerably worse because overall market risk is a much smaller proportional factor influencing the individual stock’s price. =B*Va/Vf, where Va = Market value of portfolio
N = B*Va/Vf = 1.5*$5.05mm/($250*1010) = 30 contracts (pg. 64) Therefore the gain on futures only is: 30 x (1010-902) x 250 = $810,000 (Pg. 64)
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