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Risk Management and Hedging Using Futures

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You have been hired as a Financial Analyst at "Burger Donalds" and scheduled to begin on September 1, 2012. Your first Assignment involves the Futures Markets. The Burger Production Manager informs that he wants 5 million bushels of wheat on December 31, 2012 of the year to ensure continued and uninterrupted production of Super Burgers. You glance through the Wall Street Journal on September 1 and observe these prices. [Think Cost of Carry Models]

Spot Price of Wheat on Sept 1 (Per Bushel) $7.52
October Wheat futures price (Delivery on Oct 31) $7.56
November Wheat futures price (Delivery on Nov 30) $7.58
December Wheat futures price (Delivery on December 31) $7.60

From Historical company records you know that if you buy the wheat ahead of the required time you can store it at a cost of 2 cents per bushel per month. Outline all your strategies (at least five!) and their implications.

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In risk management, specifically the use of hedging instruments such as commodity futures, the risk manager has to have the following information:
1. Requirements for the commodity in the covered period. In Burger Donaldsâ?? you need to know how many bushels of wheat you need. This information was given â?? 5 million bushels on December 31, 2012.
2. Cost of storage which is also provided.
3. Expectations on the spot price on the date the commodity is actually needed. This is important since this will drive the strategy you would eventually adopt. For example, if you expect that ...

Solution Summary

Risk management and hedging using futures are examined for a financial analyst. The spot price of wheat is determined.

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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.

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