William Hughes is an owner of one of the cargo trucking companies in the United Kingdom called Tryciau Nerthol Ltd. One day, William watches breaking news on TV and finds out that there has been an ISIS insurgency in Iraq and rebels managed to take control of a significant number of the oil wells. William jumps up on the sofa, as this news is going to have an impact on his business: around 40% of his business costs are purchases of diesel and the price is very likely to go up. He springs into action. He calls his dealer and buys 1000 3-month London gas oil futures. His business is not allowed to use a favourably taxed red diesel (traditionally called ‘gas oil’), but other diesel futures are not traded in London.Questions: Why did William buy futures for diesel which he cannot use in his business? Critically examine the concept of an imperfect hedge. Critically evaluate the timing of his action – is the time he hears the news a good time to attempt the hedge? Propose a long-term hedging strategy.
William Hughes is an owner of one of the cargo trucking companies in the United Kingdom called Tryciau Nerthol Ltd. One day, William watches breaking news on TV and finds out that there has been an ISIS insurgency in Iraq and rebels managed to take control of a significant number of the oil wells. William jumps up on the sofa, as this news is going to have an impact on his business: around 40% of his business costs are purchases of diesel and the price is very likely to go up. He springs into action. He calls his dealer and buys 1000 3-month London gas oil futures. His business is not allowed to use a favourably taxed red diesel (traditionally called ‘gas oil’), but other diesel futures are not traded in London.Questions: Why did William buy futures for diesel which he cannot use in his business? Critically examine the concept of an imperfect hedge. Critically evaluate the timing of his action – is the time he hears the news a good time to attempt the hedge? Propose a long-term hedging strategy.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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William Hughes is an owner of one of the cargo trucking companies in the United Kingdom called Tryciau Nerthol Ltd. One day, William watches breaking news on TV and finds out that there has been an ISIS insurgency in Iraq and rebels managed to take control of a significant number of the oil wells. William jumps up on the sofa, as this news is going to have an impact on his business: around 40% of his business costs are purchases of diesel and the price is very likely to go up.
He springs into action. He calls his dealer and buys 1000 3-month London gas oil futures. His business is not allowed to use a favourably taxed red diesel (traditionally called ‘gas oil’), but other diesel futures are not traded in London.Questions:
- Why did William buy futures for diesel which he cannot use in his business? Critically examine the concept of an imperfect hedge.
- Critically evaluate the timing of his action – is the time he hears the news a good time to attempt the hedge?
- Propose a long-term hedging strategy.
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