StudentShare solutions
Triangle menu

Hedging Oil Consumption - Essay Example

Nobody downloaded yet

Extract of sample
Hedging Oil Consumption

There are other inherent risks associated with business such as currency fluctuations, volatility of crude oil prices and so on. In order to reduce exposure to volatility in the market, many participants prefer hedging strategies using derivatives. A derivative is a financial instrument which derives its value from the underlying asset. One of the hedging strategies alternatives that are available to the market participants is by using futures derivative. The main purpose of futures markets is to minimise uncertainty in transactions and hence reduce risk. The basic objective of futures market is to hedge the associated risk by taking such a position so as to neutralize possibility of risk as far practicable. A futures contact is a standard contract between two market participants to buy or sell a specific asset of standard quality, quantity for a given price agreed upon on the date of contract (also known as strike price) with payment and delivery occurring at maturity date. The contracts are standard in the sense that quantity, quality, price, strike price, delivery date, initial margin, marking to market, etc. are done via intermediary and not directly negotiated between parties involved in transaction. Hence, the refinery may enter into futures contract with its customers giving them the opportunity to purchase oil at current prices at a later date in future. In this way even if the prices of oil rises in future, the refinery would not require to pass on the higher costs to their customers (CME, 2006, pp.49-53). After discussing the concept of futures, it is now important to illustrate how futures might help the US Gulf refinery to hedge risk. There are two different methods of hedging namely short hedge and long hedge. A short hedge is suitable when the hedger owns the asset (as in this case) and expects it to sell at some time in future. Thus, the oil refinery may take short position in futures contract. A long hedge on the other hand involves taking the long position (buy at later date). This strategy is suitable when the hedger (in this case customer) knows that it will have to purchase a particular asset in future but would like to purchase at current price. In both the strategies payment and deliver occurs at maturity of contact which is usually three months. To further illustrate these strategies in details, consider the following example: Assuming that on June 13 (present) the oil refinery has taken a short position by negotiating a contract to sell 1 million barrels of crude oil. It is also agreed that the price applicable in the contract will be on the market price of September 13. So, for each 1% rise, the producer will gain $10,000 and similarly for each 1% decline in price refinery will lose $10,000. The standard futures contract on CME platform is 1,000 US barrels (or 42,000 gallons), hence the company can hedge exposure by shorting 1,000 September futures contracts. If the last trading close price was $90 per barrel, strike price is $85 and assuming that price per barrel in September is actually $80, then per barrel gain of the oil refinery would be $5 (since, $85 - $80). This means the total gains for entire contract would be $5000 ($5 x 1000). Using the above example the long hedge strategy can be explained as ...Show more

Summary

HEDGING OIL CONSUMPTION Table of Contents Question 1) 3 Question 2) 5 Question 3) 7 References 9 Question 1) In today’s competitive world the market has become very volatile and it is becoming extremely difficult for the companies to predict demand successfully…
Author : antoinette09
Hedging Oil Consumption essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the essay on your topic
"Hedging Oil Consumption"
with a personal 20% discount.
Grab the best paper

Check these samples - they also fit your topic

Hedging
Secondly, Virtual Books are going to engage in import of certain products from Slovakia which will trigger a cash outflow in Euros. However in this case, the company must use its GBP account to effect the payment. Hence in both cases, Virtual Books has an exposure to potential exchange rate risk.
3 pages (750 words) Essay
Hedging Strategies
Now the case specifies that the money is received in Pound Sterling, however Slovakia has adopted the Euro as its currency and we shall assume that it remits Euros which are converted into pounds and then given to Virtual Books. The second stream of cash flows is the import payments which Virtual Books must make to its sister concern in Slovakia.
2 pages (500 words) Essay
Reducing Oil Consumption
In any case, as the oil reserves across the world continue to diminish at an astonishing rate, it is important to reduce the overdependence on oil by finding other options and formulating other means of reducing the consumption of oil. The core of the argument is therefore the need to reduce oil consumption as much as possible through various strategies and policies both through the government, private sector and other non-governmental organizations.
3 pages (750 words) Essay
Consumption
This therefore, gives a clear impression that the ways of consumerism differs from one individual to the next. There are various factors that influence the way in which an individual controls consumerism. In the whole world, every nation is different especially because of the administration.
4 pages (1000 words) Essay
The Health Benefits of Fish and Fish Oil Consumption
lishing that even though some fish species poses mercury risk to pregnant women and children, fish is generally good for Americans. The consumption of fish is scientifically proven to help in the reduction of death from heart disease. It should be noted that fish coronary heart disease is the leading cause of death among Americans.
2 pages (500 words) Essay
Analysis of the trends in the consumption patterns of oil
In this research study, the Oil Market Report by IEA is analyzed. The oil market is one where small changes to the supply or demand cause large changes to the clearing price. In economics jargon, both oil supply and demand are "inelastic" - they show only a minimal short-term response to changes in price.
4 pages (1000 words) Essay
Currency Hedging
This literature review would examine the theoretical and conceptual constructs of currency hedging strategies and their relevance or irrelevance to all firms in a highly competitive and risk prone money market. In the first instance currency hedging practices have their relative individual significance vis--vis non-currency investment opportunities and net returns on such investment vehicles (Zarin, & Zimmerman, 2006).
22 pages (5500 words) Essay
Consumption
The consumer is what makes the product, if a company came out with a brand of soda that tasted like fish it would be up to the consumer to decide whether that product survived or died. Let's assume that this company decided to test the product out on a hand full of people, if 75% of the people in this group survey said they did not like the soda it probably would never make it to the production line.
2 pages (500 words) Essay
Consumption
Shopping centers and women played very crucial roles in the creation of the identity of the modern consumer (Hamilton 571). The following paper considers the impacts of people whose consuming behavior determines and shapes their desires,
5 pages (1250 words) Essay
What actions might be taken by the government of your Uk to reduce or limit price fluctuations of oil
Although the U.K. is a major producer of Oil in Europe, it is currently a net importer of the commodity as noted by the U.S. Energy Information Administration (2013). A huge percentage of the oil that is imported into the U.K. comes from the Middle East, and more especially
4 pages (1000 words) Essay
Hire a pro to write
a paper under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
YOUR PRIZE:
Apply my DISCOUNT
Comments (0)
Click to create a comment