...Hedging Jordanian Oil Purchases' Risk and Costs Using Oil Futures Contracts During 1998-2007 Dr. Asa'ad Hameed O. AL-ali ; Mohammed Murdi Al Rawad Abstract This study aims to investigate whether using futures contracts will reduce the Jordanian imported petroleum price risk and decrease the Jordanian petroleum purchases invoice. To achieve the objectives of this study, ten years-hedge simulation conducted on the real imported quantities to generate assumed comparable cases for the unhedged and hedged costs of the Jordanian monthly purchases. The study sample consisted of Jordanian monthly imported quantities of crude oil during the 1998-2007 period. Weekly spot prices of Saudi Arabian Light Crude and the daily futures prices of NYMEX Cushing Crude Oil Futures Contracts 1 (one month) and 4 (4 months) were also used. Constant cross hedge strategy conducted for hedging the Jordanian imported petroleum needs. The NYMEX Cushing Crude Oil Futures Contracts 1 and 4 employed to hedge the Saudi Arabian light crude oil over the study period as a proxy for the Jordanian petroleum purchases. The results demonstrate that the constant cross hedge strategy with the NYMEX oil futures contract 4 proved to be successful in hedging the price risk of the Jordanian imported petroleum and decreases the purchases invoice. While that of NYMEX oil futures contract 1 increases the price risk of the Jordanian imported petroleum, but at the same time decreased the purchases...
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...Giddy Forwards, Futures and Money-Market Hedging/1 Forwards, Futures and Money Market Hedging Prof. Ian Giddy New York University Hedging Transactions Exposure Types of exposure l One-shot exposure l Hedging approaches: l u Open u Forward u Money market u Futures u Options l Ongoing transactions exposure Forwards, Futures and Money-Market Hedging 7 Copyright ©1997 Ian H. Giddy Giddy Forwards, Futures and Money-Market Hedging/2 Tools for Hedging l Petrobras has to pay for equipment from Japan, in Japanese yen, in 3 months u Borrow and pay now? u Use a forward contract/FX swap? u Pay later at spot? Copyright ©1997 Ian H. Giddy Forwards, Futures and Money-Market Hedging 8 Forward Contracts, Futures and Money Market Hedging Money market hedging: match currency of assets and liabilities l Forwards: OTC agreement to exchange currencies at certain exchange rate in the future l FX swap: simultaneous spot sale and forward purchase of a currency l Futures: Exchange-traded contracts for notional future delivery, minimizing default risk via marking-to-market l Copyright ©1997 Ian H. Giddy Forwards, Futures and Money-Market Hedging 9 Giddy Forwards, Futures and Money-Market Hedging/3 Forward Contracts Agreement to exchange currencies at certain exchange rate in the future l Default risk in forward contracts arises because such a contract is a commitment for future performance, and one or other party may be unwilling or unable...
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...FInTHE ROLE OF OIL FUTURES IN RISK MANAGEMENT From: To: Senior Management - Airlines Company November 2011 0 University of Westminster - Westminster Business School International Risk Management COURSEWORK THE ROLE OF OIL FUTURES IN RISK MANAGEMENT Student: Student ID: Course: Word count: MSc. Finance and Accounting 2557/2617 1 EXECUTIVE SUMMARY In the world today, oil is being used as the main source of energy for a lot of core industries. Due to its non-renewable characteristics and the global rising demand, oil has increased in its value, which results in many oil price crises recently. For all those industries using large amount of oil in operation, the risk of rising oil price is an extensive problem. The most efficient method to hedge against this risk is by using oil futures contracts. Because of its effectiveness, oil futures contracts are playing a key role in risk management for a number of industries including transportation and manufacturing. This report provides principal knowledge about oil futures and its role in hedging the risk of oil price volatility. A case study of US airline industry with most updated data obtained from Bloomberg system is also discussed, which suggests the effectiveness of oil futures in risk management for most airlines companies. However, in some case, the inflexible use of oil futures may create a burden in financial costs while not producing effectiveness in risk hedging. 2 TABLE OF CONTENTS LIST OF...
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...Giddy | Hedging 1 Hedging Techniques Dr. Ian Giddy New York University Techniques of Hedging A brief comparison of hedging tools Forwards, futures, swaps Asset-liability matching Pricing and linkages among the tools Uses and abuses of options When to use, and when not to use Copyright ©2009 Ian H Giddy 4 Giddy | Hedging 2 What Hedging Instruments? What Protection Needed? Volatility & Direction Direction Complex risks Or arbitrage Exotics, Hybrids, structured notes OTC options, Caps and Floors Forwards, Futures, Swaps Copyright ©2009 Ian H Giddy 5 Tools for Hedging Petrobras has to pay for equipment from Japan, in Japanese yen, in 3 months Borrow and pay now? Use a forward contract/FX swap? Pay later at spot? Copyright ©2009 Ian H Giddy 6 Giddy | Hedging 3 Forward Contracts, Futures and Money Market Hedging Money market hedging: match currency of assets and liabilities Forwards: Agreement to exchange currencies at certain exchange rate in the future Futures: Exchange-traded contracts for notional future delivery, minimizing default risk via marking-tomarket Currency swap: match payments on foreign-currency debt Interest-rate swap: change floating cost to fixed Copyright ©2009 Ian H Giddy 7 A Typical Forward Exchange Contract We agree today to pay a certain price for a currency in the future JPY Sony Sony B of A B of A Copyright ©2009 Ian H Giddy 8 Giddy | Hedging 4 Forward Quotations ...
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...derivative as a financial instrument or other contract within the scope of IFRS 9 that meets three criteria: 1. Its value changes in response to a change in an "underlying". The underlying can be the price of a commodity, such as soybeans, or a financial instrument, such as a fixed rate bond. It can also be a rate such as a foreign exchange rate or a specified interest rate, for example, the London Interbank Offer Rate; It requires little or no initial net investment; and It is settled at a future date. 2. 3. Chapter 10 Page 1 TABLE 10.1 Examples of derivative instruments and their underlying Type of derivative instruments Options contract (call and put) Underlying Security price Used by Producers, trading firms. financial institutions and speculators Various companies Producers and consumers Financial institutions Forward contracts, e.g. foreign Foreign exchange rates exchange forward contracts Futures contracts, e.g. Commodity prices commodity futures Swaps. e.g. interest rate swap Interest rate Uses of Derivatives Generally, firms or individuals transact in derivatives to: 1. Manage market risks such as foreign exchange risk and interest rate risk; 2. 3. Reduce borrowing costs; or Profit from trading or speculation. Chapter 10 Page 2 Types of derivatives Ø Forward-type derivatives o Forward contract o Future contract o Swaps Ø Option-types derivatives o Option contract o Caps o Collars o Warrants Chapter...
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...Analysis Link Technologies Case Report The derivatives program was reducing risk when the firm was investing in foreign currency futures for the first four months from the implementation date (February 1991 to May 1991). This is seen by the negative correlation of (0.94226594) between the derivative (futures) cash flow and the unhedged cash flow. A purpose of a perfect hedge is to obtain a net of zero or in other words, reduce your risk to nothing not including the cost of the hedge. If a correlation is negative, as it was for the first three months, it means that investing in futures contracts was the right move because the cash flows are moving in opposite directions to minimize the risk. Another way to evaluate the performance of the hedging strategy is to compare the variance of unhedged cash flow and the hedged cash flow, expecting that that variance of the unhedged should be greater than the hedged cash flow. As seen in the table below, the variance of the unhedged is greater than the variance of the hedged when Link Technologies invested in currency futures contracts. Futures Variance | | Unhedged CF | 20,691,861,693.67 | Hedged CF | 2,774,199,924.92 | Difference | 17,917,661,768.75 | Even though, the hedging program was perfectly implemented, Mr. Lee strongly believed that investing in futures was the wrong approach because the company experienced a loss of half a million dollars during the first three months. So, he “suggested”...
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...Introduction 1. “Hedging” Defined 2. The Hedging Process 1. The Fuel Hedging Decision-making 2. Steps in the Hedging Process 3. Different types of Hedging Strategies 4. The Accounting Aspects of Hedging 5. Formula used in the Spot Pricing of Jet Fuel 3. Pros and Cons Arguments of Hedging Jet Fuel 4. Risk Factors that may affect the Hedging of Jet Fuel. 5. Conclusion 6. Data Analysis, Graphics and Tables 7. Bibliography Introduction The hedging of jet fuel by major airlines is the topic of this project. Hedging is considered by some as a form of insurance, similar to the kind you buy for your personal use (health, life, auto) or for your business (fire, flood, cargo). The process of hedging fuel and its derivatives is far more complicated than going out to buy a homeowner’s insurance policy, for example. We will address the different types of hedging strategies that can and are being implemented by some of the major global carriers and we will also take a look at those carriers who do not practice hedging at all. Hedging allows airlines to “insure” themselves against a negative event, such as a sharp rise in fuel prices due to a shortage in oil production. Hedging is simply a way that some airlines use to try and reduce the uncertainty and volatility of jet fuel prices. For example, if a major airline is currently generating a profit, they can try to protect that profit by hedging their fuel needs and...
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...Introduction: Overview of the hedging techniques: In the financial market, almost all of companies need to face the currency risk. In order to manage the currency risk, companies will use different hedging techniques, such as financial and operational hedging techniques. For example, money market, futures contracts, options and forwards contracts are commonly used by firms, as well as operational hedging techniques. All of 4 types of financial hedging techniques are short-term hedge. Money market is a part of financial markets for assets involved in short-term borrowing,lending, buying and selling. Its features are high liquidity, lower risk, such as treasury bills. Futures contracts are future transaction for buying or selling, and made by Futures exchange. The date and place of the transaction have been provided. There are some features of futures contracts. Quantity, commodity and quality have been limited, excepting the price. Also, it cannot be done over-the-counter. Options is a financial tool, which based on futures. If purchaser hold the options, he/she will has a right, not the obligation, to buy from or sell to the seller of the provided commodity in the future as the same price as the price agreed now. The last financial hedging technique, forwards contracts, is a non-standardization contact between two parties to sell or buy in the future. Curb-exchange and cash transaction are the feathers of forward contact. This essay will focus on two operational hedging techniques, market...
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...the future income for the business. If we never watch transactions in line with the recent development in the market, it actually leads to dangerous situation; where in there won’t be any control on the business and eventually leading to loosing the existence of business. Let us understand the business model of Thomas Foods which is incorporated in the year 1969. Viewing the business model of Thomas Foods, it procures the very crops from farmers and they supply the same to the grocery stores. Due to the environment conditions, the price of the crops keep changing very often and it also happens that, if due to certain bad weather conditions, the price of the crops increases, it will be extremely difficult for Thomas Foods to continue the business and balance the activities. So in order to ensure that there is a good amount of crops available at a particular price and in order to ensure that, the operating income of the company is not at a stake, the company has thought of certain strategies which will protect cash flows along with operating income. So the process of downsizing the risk of price increase for the crops and in order to do a sustainable business, the company should go adopting hedging tools. Hedging is a strategy, where in the corporations protects their cash flows and the business for the near futures and ensures that the profitability for the corporation is not at a risk. So the management of the company should ensure that there is adequate amount of hedging strategies...
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...Fuel Hedging in the Airline Industry: The Case of Southwest Airlines Executive Summary From December 21, 1998 to September 11, 2000, jet fuel prices increased 255%, from 28.50 cents/gallon to 101.25 cents/gallon. While jet fuel prices have declined from their highs, at a price of 79.45 cents/gallon, they are still significantly above the December 1998 lows. With the future price of jet fuel being unpredictable, Southwest has decided to implement a trading strategy in an effort to mitigate its exposure to adverse price movements in jet fuel. To do this, Southwest has settled on 5 possible strategies: (1)Do nothing; (2) Hedge using plain vanilla jet fuel or heating oil swap; (3) Hedge using options; (4) Hedge using a zero-cost collar strategy; or (5) Hedge using a crude oil or heating oil futures contract. The merits and demerits of each strategy are discussed in depth below. After evaluating the possible scenarios, it is our recommendation that Southwest implement a hedging strategy that involves a combination of the jet fuel swap and the heating oil swap. The combined strategy will allow Southwest to achieve the lowest net jet fuel costs, while limiting the risks associated with the strategies individually, such as counterparty risk for the jet fuel swap and basis risk for the heating oil swap. Concerning the split between the two strategies, a 50/50 even split is recommended. Why Hedge? Hedging is a financial strategy that enables airlines or other investors...
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...Global Financing and Exchange Rate Mechanisms Michael C. McGee MGT/448 November 6, 2012 Ian Finley Global Financing and Exchange Rate Mechanisms Globalization is ushering in tremendous business opportunities, competitive advantages, and greater profitability for companies that choose to set up operations in foreign countries. However, along with these opportunities come various risks to these companies. One of the main risks these companies will face is foreign currency exchange rate risk. Companies that plan to set up operations in a foreign country must exchange its domestic currency into the currency of the host nation to buy the necessary building materials, supplies, and other necessary resources that the operations will require (Hill, 2009). For example, if a U.S. company desires to set up operations in the country of China, it will have to exchange U.S. dollars currency into Chinese currency-the Yuan. If a company in Japan wants to set up operations in Spain or Italy, it would have to exchange its currency- the Yen into these countries’ currency, which is the Euro. The foreign currency exchange rates between these countries consistently fluctuate causing one to appreciate or depreciate against the other. The unpredictable movement of the foreign currency exchange rates can have adverse effects on a company’s investments, and profits that have operations in a foreign country. Foreign companies with operations in the U.S. normally convert the dollars it earns back...
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...it had to give out. This caused large losses over the period 1979-1982 when interest rates rose. Table 1.1 The bank would violate the regulatory capital requirements if its losses were not controlled. The T-bill interest rates were on the rise. $400mm in savings certificates were to be rolled over on September 1. If interest rates continued to rise, then these certificates would be rolled over at the prevalent high interest rates (as mentioned in the case, the savings certificate interest rate was fixed at a spread over the T-bill interest rate). If the firm hedges itself from the interest rate fluctuations, then the loss that would be caused due to the savings certificate rollover at a high interest rate would be offset by the futures position. Let us look at this in detail: From exhibit 3, Profit and Loss Statement, comparison of the interest payment expenses ( as denoted by Dividends) has increase from 1979 to 1981 by 104.3% which is attributed to the rise in T-bills interest rates. Table 1.2 Time Period 1981 1980 1979 % Increase from 1979 to 1981 Dividends (denotes interest paid or credited to members) 40,162 26781 19660 104.3% Net Income (3125) 800 2169 Table 1.3 Time Period 1981...
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...the dollar exposure that must be provided by a position in the futures contract. The following relationship holds: If target dollar duration > current dollar duration, buy futures If target dollar duration < current dollar duration, sell futures Dollar duration per futures contract: an illustration Assume the price of an interest rate futures contract is 70 and that the underlying interest rate instrument has a par value of $100,000. Thus, the futures delivery price is $70,000 ($100,000 x 0.7). Suppose that a change in interest rates of 100 basis points results in a futures price change of about 3% per contract, then the dollar duration per futures contract is $2,100. Hedging Hedging is a special case of controlling interest rate risk. In a hedge, the manager seeks a target duration or target dollar duration of zero. Hedging with futures calls for taking a futures position as a temporary substitute for transactions to be made in the cash market at a later date. If cash and futures prices are perfectly positively correlated, any loss realized by the hedger from one position will be exactly offset by a profit on the other position. A short hedge is used to protect against a decline in the cash price of a bond. To execute a short hedge, futures contracts are sold. A long hedge is undertaken to protect against an increase in the cash price of a bond. In a long hedge, the manager buys a futures contract to lock in a purchase price. A pension fund manager might use...
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...provide them with hedging options to mitigate their risk in regards to unexpected increase in harvested crop prices. Thomas Foods purchases produce from local farmers and sells to grocery stores throughout the country. Any variance in crop price has an effect on the operating income of the business and therefore it is extremely important in order to continue to be profitable that the prices of crops are forecasted correctly. Hedging options will allow Thomas Foods to ensure they are able to purchase crops at a guaranteed price and quantity, hence protecting the cash flow and operating income of the business. I have come up with three hedging options that would be best suited for Thomas Foods, the pros and cons of each, and included information regarding the accounting for these options as well as the guidance given by FASB. Hedging options that Thomas Foods has to mitigate the risk of paying more for harvested crops include: -Future contracts which are contractual agreements, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. So we can negotiate price now with our farmers on the prices that we will pay for the crops in the future and that price will be locked in. ("Futures Contract Definition | Investopedia," n.d.) -Forward contracts which are contracts that are customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward...
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...Soluion: Application for Financial Futures Case Solution for 'Peoples Federal Savings Bank' 1. Should Peoples Federal Savings have hedged its September 1 savings certificate rollover? Yes. The reasons are explained as below: Peoples had accumulated assets of $556m. These assets were funded by short term consumer deposits, consisting largely of 3-month fixed rate savings certificates. These savings certificates were highly affected by interest rate fluctuations. The long term loans provided to people generate interest earnings which are do not increase or decrease with the interest rate fluctuations. Therefore, there was a mismatch between the interest rates earned by the bank and the interest rates that it had to give out. This caused large losses over the period 1979-1982 when interest rates rose. Table 1.1 The bank would violate the regulatory capital requirements if its losses were not controlled. The T-bill interest rates were on the rise. $400mm in savings certificates were to be rolled over on September 1. If interest rates continued to rise, then these certificates would be rolled over at the prevalent high interest rates (as mentioned in the case, the savings certificate interest rate was fixed at a spread over the T-bill interest rate). If the firm hedges itself from the interest rate fluctuations, then the loss that would be caused due to the savings certificate rollover at a high interest rate would be offset by the futures position. Let us look at this...
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