Principles of Finance · free preview
Commodity Price Risk
Firms manage commodity price risk through long-term supply contracts, vertical integration, and futures contracts, with futures offering liquid, exchange-guaranteed hedges whose marking-to-market removes counterparty risk.
1. The exposure and the menu
The exposure and the menu
2. Vertical integration
Vertical integration
3. Futures contracts
Futures contracts
4. Choosing among the three
Choosing among the three
5. The double direction
Commodity price risk flows in which directions for different firms?
6. Long-term contracts' weakness
What is the principal weakness of hedging through long-term supply contracts?
7. Vertical integration's trade
Why is vertical integration usually a strategic decision rather than a pure hedge?
8. The futures mechanism's safety
How do futures exchanges remove counterparty risk?
9. The offset in a falling market
An airline buys fuel futures and the fuel price then falls. What happens?
10. Basis risk's residue
What residual risk remains even in a well-designed futures hedge?
11. The daily settlement's name
What two-word term names the daily exchange of gains and losses on futures positions? Answer in lowercase.
12. The collateral's name
What one-word term names the collateral futures traders post to guarantee performance? Answer in lowercase.
13. The ownership hedge's name
What two-word term names hedging by merging with one's supplier? Answer in lowercase.
14. The offset position's rule
To hedge a future physical purchase, a firm should buy or sell futures today? Answer with one word.
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