Financial derivatives
On January, an airline company, selling tickets well in advance, wants to hedge against the risk
associated with jet fuel price fluctuations. In the absence of Futures contracts traded on jet fuel,
they choose to use NYMEX Futures contracts on heating fuel oil. The futures prices of heating
fuel oil is $3.28 per gallon.
Suppose the standard deviation of monthly changes in the price of jet fuel is $0.035, the standard
deviation of monthly changes in the Futures price of heating fuel oil is $0.040 and the
correlation between the two is 0.85.
1) What is the optimal hedge ratio for a 1-month contract? What does it mean?
2) If your initial exposure is on buying 1.5 million gallons of jet fuel, and the size of the
NYMEX Futures contract on heating fuel oil is 42,000 gallons, how should you tailor
your hedge?
One month later, the company buys jet fuel on the spot market for a price of $3.22 per gallon.
The same day, the futures position is closed out at a price of $3.25 per gallon.
3) What is the profit/loss from the futures position? And what is the effective price per
gallon?
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Jun HO futures) when F1 week=1.40, and purchased 4.2
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