By completing this case you will:
– Learn to work with futures and spot data
– Estimate hedge ratios
– Compute hedged and unhedged valuation changes with historical data
– Back-test and discuss possible hedging strategies
– Consider how hedge ratio estimates can be employed in dynamic settings
– Communicate complex analysis to a non-technical audience
Learning Activities
By completing this case you will:
– Estimate and/or compute hedge ratios
– Compute cash flows to hedging strategies using energy futures contracts
– Comment on the consequences of changing market conditions on
possible hedging strategies
– Write a brief report for a non-technical audience
Task
You are an associate at a commercial bank. One of your colleagues has sent the
following email:
“Thanks again for sending Hull’s chapter on hedging with futures. As you
know we do a lot of work with energy-intensive companies, so one of his
examples seemed especially relevant. His cross-hedging strategy (jet fuel and
heating oil) is interesting, but we were wondering what would happen in
turbulent markets? For example in 2014 crude oil dropped from about USD
100 per barrel to around USD 50 per barrel. What would happen to someone
using Hull’s proposed strategy over this time? Would it make sense to
consider other energy futures as part of a hedging strategy (i.e. we have been
wondering about including crude oil futures in addition to heating oil)?
Any thoughts you have would be greatly appreciated.”
Your colleague has limited quantitative skills and so you feel that you can best
demonstrate these concepts through a clear example, based on data taken from the
period she noted
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