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Hedging

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Please help me figure out the following hedging problems.

Problem 1: Hedging Commodities

Bubbling Crude Corporation, a large Texas oil producer, would like to hedge against adverse movement in the price of oil because this is the firm's primary source of revenue. What should the firm do? Provide at least two reasons why it probably will not be possible to achieve a completely flat risk profile with respect to oil prices.

Problem 2: hedging exchange rate risk

If a U.S. company exports its goods to Japan, how would it use a futures contract on Japanese Yen to hedge its exchange rate risk? Would it buy or sell yen futures? Does the way the exchange rate is quoted in the futures contract matter?

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Solution Summary

The solution explains two hedging problems relating to commodities and exchange rate risk.

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Problem 1: Hedging Commodities

Bubbling Crude Corporation, a large Texas oil producer, would like to hedge against adverse movement in the price of oil because this is the firm's primary source of revenue. What should the firm do? Provide at least two reasons why it probably will not be possible to achieve a completely flat risk profile with respect to oil prices.

The firm is an oil producer and oil is the primary source of revenue. This implies that if the price of oil falls, then the revenues of the ...

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