FINANCE-You are a financial manager at Alaska Airlines

QUESTION

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?

ANSWER:

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