Reference no: EM132809593

It is? March, and Alberta Oil Refinery? (AOR) has enough crude oil in inventory to continue refinery operations until September. AOR expects to need to purchase 500,000 barrels of oil in September. Management at AOR is concerned about oil price volatility. Futures contracts for September delivery are available with a futures price of ?$110 per barrel. Options contracts with a strike price of ?$110 and expiration in September are also? available; puts cost ?$28 and calls cost ?$20. Complete parts a through e.

Problem a. Describe how AOR can fully hedge using oil futures contracts.

A. AOR can hedge by taking a short position in futures for 500,000 barrels of oil for September delivery.
B. AOR can hedge by taking a long position in futures for 500,000 barrels of oil for September delivery.
C. AOR can wait until prices rise in the future.
D. AOR can hedge by taking an intermediate position in futures for 500,000 barrels of oil for September delivery.

Problem b. Given the strategy in a?, what will be the total net amount paid by AOR? (for all 500,000 ?barrels) if the price of oil in September is as? follows:

i. ?$60 per? barrel;
ii.? $110 per? barrel;
iii. ?$160 per barrel

Problem c. Describe how AOR can fully hedge using options.

A. AOR can purchase the call options on 500,000 barrels of oil.
B. AOR can sell the call options on 500,000 barrels of oil.
C. AOR can sell the put options on 500,000 barrels of oil.
D. AOR can purchase the put options on 500,000 barrels of oil.

Problem d. Given the strategy in c?, what will be the total net amount paid by AOR? (for all 500,000 ?barrels) if the price of oil in September is as? follows:
i.? $60 per? barrel; ii.? $110 per? barrel; iii.? $160 per barrel

Problem e. AOR has asked for your advice regarding hedging. Discuss how the each of the following individually will influence your advice. Choose one of the bolded.

i. AOR does not expect to have much cash available between April and August. In this? case, AOR will choose to choose or avoid the futures hedge?

ii. AOR thinks that a drop in oil prices will occur if the economy goes into recession. There is a? 33% chance this will happen. In a? recession, demand for? AOR's refined oil products will drop by half. In this? case, AOR should choose the options hedge, the futures hedge or no hedge?
iii. AOR will experience extreme financial distress costs if its net revenues in August do not cover the net costs of oil purchased then. AOR net revenues are estimated to be ?$60 million. In this? case, AOR should choose no hedge, the futures hedge, or the options hedge?

iv. AOR will experience extreme financial distress costs if its net revenues in August do not cover the net costs of oil purchased then. AOR net revenues are estimated to be? $50 million. In this? case, AOR should choose no hedge, the futures hedge, or the options hedge?

v. AOR can pass along any price increases in oil by increasing the prices of its refined products. In this? case, AOR should choose no hedge, the futures hedge, or the options hedge?