1. The one-year at-market forward price for jet fuel is $6.20/gal. A jet fuel call option expiring in one year with a $6.20 strike price currently sells for a premium of $0.3526. A put option with the same expiration and strike price also sells for $0.3526. The risk-free, continuously compounded interest rate is 5.5%. Northeast Airlines expects to be able to generate net revenue of $9.00 per gallon of jet fuel used. (Assume net revenue will be received at the time the jet fuel is delivered one year from today; that is, the $9.00 is the future value of net revenue). a. (2 points) If Northeast Airlines wants to use the forward market to manage the risk resulting from its exposure to changes in jet fuel prices, what transaction(s) should it make on that market? b. (5 points) The first column of the table below indicates some possible prices of jet fuel when the forward contract matures. Fill in the remainder of the table. Unmanaged payoff/profit refers to the results without any risk management Managed payoff and profit refer to results assuming Northeast Airlines manages risk with forward contracts as suggested in (a). forwd contract managed payoff payoff forward contract cost managed profit jet fuel unmanaged price prod. cost payoff-profit 5.80 9.00 6.00 9.00 6.20 9.00 9.00 6.60 9.00 6.40 c. (3 points) The managed payoff profile that results (that is the schedule of payoffs as a function of the price of jet fuel) is equivalent to what financial instrument(s)? In other words, if you did not own an airline, what financial instrument (or collection of instruments) could you buy to receive this same payoff profile in one year? d. (2 points) If Northeast wants to use the options market to cap its potential cost of jet fuel, what e. (4 points) For each possible fuel price indicated, fill in the table below. Unmanaged payoff/profit refers to the results without any risk management Managed payoff and profit refer to results assuming Northeast manages risk with option contracts as suggested in (d). option contract managed payoff payoff option contract cost managed profit jet fuel unmanaged price prod. cost payoff-profit 5.80 9.00 6.00 9.00 9.00 9.00 6.609.00 F. (4 points) The managed payoff profile that results is equivalent to what financial instrument(s)? That is, if you did not own an airline, what financial instrument (or collection of instruments) could you buy to receive this same payoff profile in one year? 1. The one-year at-market forward price for jet fuel is $6.20/gal. A jet fuel call option expiring in one year with a $6.20 strike price currently sells for a premium of $0.3526. A put option with the same expiration and strike price also sells for $0.3526. The risk-free, continuously compounded interest rate is 5.5%. Northeast Airlines expects to be able to generate net revenue of $9.00 per gallon of jet fuel used. (Assume net revenue will be received at the time the jet fuel is delivered one year from today; that is, the $9.00 is the future value of net revenue). a. (2 points) If Northeast Airlines wants to use the forward market to manage the risk resulting from its exposure to changes in jet fuel prices, what transaction(s) should it make on that market? b. (5 points) The first column of the table below indicates some possible prices of jet fuel when the forward contract matures. Fill in the remainder of the table. Unmanaged payoff/profit refers to the results without any risk management Managed payoff and profit refer to results assuming Northeast Airlines manages risk with forward contracts as suggested in (a). forwd contract managed payoff payoff forward contract cost managed profit jet fuel unmanaged price prod. cost payoff-profit 5.80 9.00 6.00 9.00 6.20 9.00 9.00 6.60 9.00 6.40 c. (3 points) The managed payoff profile that results (that is the schedule of payoffs as a function of the price of jet fuel) is equivalent to what financial instrument(s)? In other words, if you did not own an airline, what financial instrument (or collection of instruments) could you buy to receive this same payoff profile in one year? d. (2 points) If Northeast wants to use the options market to cap its potential cost of jet fuel, what e. (4 points) For each possible fuel price indicated, fill in the table below. Unmanaged payoff/profit refers to the results without any risk management Managed payoff and profit refer to results assuming Northeast manages risk with option contracts as suggested in (d). option contract managed payoff payoff option contract cost managed profit jet fuel unmanaged price prod. cost payoff-profit 5.80 9.00 6.00 9.00 9.00 9.00 6.609.00 F. (4 points) The managed payoff profile that results is equivalent to what financial instrument(s)? That is, if you did not own an airline, what financial instrument (or collection of instruments) could you buy to receive this same payoff profile in one year
