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Derivatives for fuel price hedging: A review

   

Added on  2021-04-24

14 Pages3533 Words215 Views
FinanceCalculus and AnalysisEconomics
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Running head: FINANCIAL ENGINEERINGFinancial EngineeringName of the Student:Name of the University:Authors Note:
Derivatives for fuel price hedging: A review_1

FINANCIAL ENGINEERING1Table of ContentsIntroduction:...............................................................................................................................2Literature review on use of derivatives by jet fuel traders and airline companies for fuel pricehedging:......................................................................................................................................2Critically comparing on the strategies used by the company, while identifying the position,which turned against them:........................................................................................................4Stating after the evaluation whether no hedge is better than hedge:..........................................7Suggesting control mechanisms that could be used by companies to protect them againstwrong use of derivatives transactions:.......................................................................................8Conclusion:................................................................................................................................9Reference and Bibliography:....................................................................................................11
Derivatives for fuel price hedging: A review_2

FINANCIAL ENGINEERING2Introduction:The overall assessment mainly provides a gist of global derivatives market that iscurrently present within the global market. In today's context there are different layers ofcontracts and instrument, which is used by investors, bankers, institutions, security fund andother traders to hedge the risk and increase profits from investment. Without the use ofhedging investors are not able to reduce the risk attributes and increase returns frominvestment. Currently the hedging of crude oil is a necessary requirement for all companiesfalling under fuel and airline industry. The rising or declining cost of crude oil effectoperation capability of both fuel and allied industries. Consequently, the use future andforward contracts to hedge their relevant risk from investment. forward and future contractsare relative instrument that allows the companies to reduce the exposure of volatile prices andfix their expenses.Future and forward contract are useful in hedging the risk of rising prices,which might occur due to the instability in supply of crude oil (Bartram 2017). The main aimof fuel and airline industry is to reduce the cost of acquiring oil and increase the profits in theoperations. However, the fuel industry has a contrary view from Airline industry, as theyprefer rising crude oil prices for increasing the profits. On the other hand, airline industryneeds low-cost fuels to generate high revenues and reduced their expenses for cash outflow.Therefore, both the industries can use forward and future contracts for reducing the risk fromvolatile crude oil prices.Literature review on use of derivatives by jet fuel traders and airline companies for fuelprice hedging:Currently there are 4 different types of derivatives that is used by Jet fuel trader’saniline companies for hedging their fuel prices. These different types of derivatives relativelyhelp in reducing of curbing the high risk involved in prices of fuel.
Derivatives for fuel price hedging: A review_3

FINANCIAL ENGINEERING3Purchasing current oil contracts:Purchasing call contacts option is relatively used by airline companies when theybelieve that prices will relatively rise in future. This could eventually help in reducing the riskfrom high oil prices, which might hamper their profitability. This type of hedging processrelatively allows airline companies to mitigate the risk from rising future prices bypurchasing large amounts of current oil contracts, which could be used over the period of 12months.The process requires high exposure of risk from volatile oil prices, which needs to beconducted thoroughly and with adequate research. Without adequate research the method ofpurchasing or hedging the current oil market might hamper profitability and expenses of thecompany (Cifarelli and Paladino 2015). The main aim of the process is to hedge airlinecompanies against rising oil prices.Purchasing Call Options:The second hedging method that is used by airline companies are purchasing calloptions, which relatively helps in fixing the specific price for the commodity at a particulardate range. This relatively helps the airline companies to hedge against the rising oil pricesthat might incur during their trade sphere.The call option relatively fixes the price of acommodity on certain range, which airline company is willing to pay after completion of thecontract. During this period any incline in prices of crude oil would have immenselybenefited the airline companies by reducing their expenses, which increases their profitabilityfrom operations.However, Afza and Alam (2015) argued thatcall option is a relativelybeneficial for the company to fix the price, while they lose money when oil prices go belowthe strike price.Implementing a Collar Hedge:
Derivatives for fuel price hedging: A review_4

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