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Design a strategy to hedge the risk of rising fuel prices

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1. You are a financial manager at Alaska Airlines.  Jet fuel prices have decreased dramatically over the past year to a current spot price of $3.10 a gallon.  You are concerned that jet fuel prices will rise over the next few months.  You need to acquire 500,000 gallons of jet fuel on May 2016.  May jet fuel futures are currently priced at $3.16 and the contract size is 25,000 gallons.

A. Design a strategy to hedge the risk of rising fuel prices.

B. If you employ this strategy, what is your effective purchase price of jet fuel if the spot and futures price is $3.50 a gallon in May 2016?

C. If you employ this strategy, what is your effective purchase price of jet fuel if the spot and futures price is $2.95 a gallon in May 2016?

2. On July 1, a portfolio manager holds $1.3 million face value of Treasury bonds, which are the 11.25s maturing in about 29 years.  The price is 107 14/32.  The bond will need to be sold on August 30.  The manager is concerned about rising interest rates and believes a hedge would be appropriate.  The September T-bond futures price is 77 15/32 and the contract size is $100,000 of bonds.

A. What hedging strategy should the firm employ on July 1? Why?

B. On August 30, the bond was selling for 101 12/32 and the futures price was 73 5/32.  Determine the outcome of the hedge. Is there an overall gain or loss and how much?

Reference no: EM132443402

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