1.An airline knows that it will need to purchase 10,000 metric tons of jet fuel in three months. It wants some protection against an upturn in prices using futures contracts. The company can hedge using heating oil futures contracts traded on NYMEX. The notional for one contract is 42,000 gallons. As there is no futures contract on jet fuel, the risk manager wants to check if crude oil could provide an efficient hedge instead. The current price of jet fuel is $277/metric ton. The futures price of heating oil is $0.6903/gallon. The standard deviation of the rate of change in jet fuel prices over three months is 21.17%, that of futures is 18.59%, and the correlation is 0.8243.

i.Determine the notional and standard deviation of the unhedged fuel cost in dollars

(5 Marks)

ii.The optimal number of futures contract to buy/sell, rounded to the closest integer

(5 Marks)

iii.The standard deviation of the hedged fuel cost in dollars(5 Marks)