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Risk Management and Hedging Using Forwards

You have been hired by Amerikan Airlines. Your primary task is to keep the Airline in Business and to ensure that you have to accomplish these two goals:
1. Keep airfares low and at a comparable steady price throughout the year
2. Protect the airline from fluctuating fuel costs

With these objectives you need to develop Hedging strategies in the Forward Market. An historical Review reveals that the Airline consumes 1 million barrels of fuel during the planned horizon and the price of fuel has fluctuated in the previous 5 years from $30.00 to $145.00. Fuel cost represents about 35% of the cost of operation and is next in importance to salaries and wages.

Identify the steps you would initiate to protect the company from fluctuating fuel costs and achieve your above two objectives.

Solution Preview

The company would need to hedge its purchases by purchasing futures or forward contracts available in the financial markets. The company can buy futures covering its purchases for the year and thus, lock-in the ...

Solution Summary

Discusses protection from fluctuating fuel costs by hedging.