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##### FIN 370 Week 5 My Finance Lab

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Problem 1 (Hedging with forward contracts);The Specialty Chemical Company operates a crude oil refinery located in New Iberia, LA. The company refines crude oil and sells the by-products to companies that make plastic bottles and jugs. The firm is currently planning for its refining needs for one year hence. Specifically, the firm's analysts estimate that Specialty will need to purchase 1 million barrels of crude oil at the end of the current year to provide the feed stock for its refining needs for the coming year. One million barrels of crude will be converted into by-products at an average cost of \$10 per barrel that Specialty expects to sell for \$185 million, or \$185 per barrel of crude used. The current spot price of oil is \$130 per barrel and Specialty has been offered a forward contract by its investment banker to purchase the needed oil for a delivery price in one year of \$135 per barrel.;a. Ignoring taxes, what will Specialty's profits be if oil prices in one year are as low as \$115 or as high as \$155, assuming that the firm does not enter into the forward contract?;b. If the firm were to enter into the forward contract, demonstrate how this would effectively lock in the firm's cost of fuel today, thus hedging the risk of fluctuating crude oil prices on the firm's profits for the next year.;Problem 2 (Fill in the Blank);Because????.. to post margin when they enter into a future contract and because they mark to market???????, we are ????.the party and the counterparty to the contract have already posted the gain or loss to the other and the risk of default ????;Problem 3 (Construct a Graph);Construct a delivery date profit or loss graph for a short position in a forward contract with a delivery price of \$60. Analyze the profit or loss for values of the underlying asset ranging from \$40 to \$80.;Which of these graphs shows the correct profit/loss line for the short forward contract on the delivery date T?;Problem 6 (Construct a Graph);Construct a delivery date profit or loss graph for a long position in a forward contract with a delivery price of \$75.00. Analyze the profit or loss for values of the underlying asset ranging from \$55 to \$100;a. Which of these graphs shows the correct profit/loss line for the long forward contract on delivery date T

Paper#73829 | Written in 18-Jul-2015

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