Canuck Oil Corporation is a Canadian crude oil producer. Today is July 15. Canuck’s estimated oil production level in three months’ time will be 100,000 barrels. The current spot price for crude oil is US$90.29 per barrel. Between January 15 and now, crude oil prices have fluctuated from a high of $110.82 to a low of $90.56. Due to the unstable nature of crude oil prices, Canuck Oil’s financial manager, Mr. Petro Stark would like to hedge the crude price risk using crude oil futures contracts. Petro found the following information on futures contracts expiring in September, October, and November: Delivery month Last Change Prior settlement Open High Low Volume September 90.79 –0.58 91.37 91.24 91.44 89.76 9067 October 92.18 –0.48 92.66 92.89 95.22 89.30 5229 November 90.13 –0.35 90.48 90.22 90.55 89.08 1685 Contract size: 1,000 barrels Contract currency: US dollar September expiry: September 16 October expiry: October 16 November expiry: November 16 What will be the gain or loss on the futures contracts? Aside from futures contracts, what other derivative instruments can the company use to hedge its exposure to crude oil prices?
Case 1: Hedging Case
Canuck Oil Corporation is a Canadian crude oil producer. Today is July 15. Canuck’s estimated oil production level in three months’ time will be 100,000 barrels. The current spot price for crude oil is US$90.29 per barrel. Between January 15 and now, crude oil prices have fluctuated from a high of $110.82 to a low of $90.56.
Due to the unstable nature of crude oil prices, Canuck Oil’s
|
Delivery month |
Last |
Change |
Prior settlement |
Open |
High |
Low |
Volume |
|
September |
90.79 |
–0.58 |
91.37 |
91.24 |
91.44 |
89.76 |
9067 |
|
October |
92.18 |
–0.48 |
92.66 |
92.89 |
95.22 |
89.30 |
5229 |
|
November |
90.13 |
–0.35 |
90.48 |
90.22 |
90.55 |
89.08 |
1685 |
- Contract size: 1,000 barrels
- Contract currency: US dollar
- September expiry: September 16
- October expiry: October 16
- November expiry: November 16
- What will be the gain or loss on the futures contracts?
- Aside from futures contracts, what other derivative instruments can the company use to hedge its exposure to crude oil prices?
3) Canuck Oil is also exposed to interest rate risk, as it has issued 2,000 fixed rate coupon bonds with a face value of $1,000 each. The current interest rate on similar coupon bonds is 8%. The company can also borrow at a rate of prime + 2%. Mr. Rich believes that the interest rate will fall in the future, and would like to see if the company can switch to a flexible interest rate on its debt. Describe how the company and its investment dealer can design a plain vanilla swap with a counterparty who can borrow at a fixed rate of 10% or a flexible rate of prime + 1%. The investment dealer generally makes a spread of 1% on this type of swap. Use a diagram to illustrate this swap transaction.
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