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Fuel price risk is the risk that future cash flows will fluctuate because of changes in jet fuel prices. In order to manage its exposure

Fuel price risk is the risk that future cash flows will fluctuate because of changes in jet fuel prices. In order to manage its exposure to jet fuel prices and to help mitigate volatility in operating cash flows, Air Canada can elect to enter into derivative contracts with financial intermediaries. Air Canada may use derivative contracts based on jet fuel, heating oil and crude oil. Air Canadas policy permits hedging of up to 75% of the projected jet fuel purchases for the current calendar year, 50% of the projected jet fuel purchases for the next calendar year, and 25% of projected jet fuel purchases for any calendar year thereafter. These are maximum (but not mandated) limits. There is no minimum monthly hedging requirement. Air Canada performs regular reviews to assess market conditions and adjust its hedging strategy where management considers it warranted. In 2019, Air Canada purchased crude oil call options covering a portion of 2019 fuel exposure. The cash premium related to these contracts was $14 million ($17 million in 2018 for 2018 exposures). Fuel derivative contracts cash settled with no fair value ($19 million in favour of the counterparties in 2018). Associated premium costs and any hedging gains and losses are reclassified from other comprehensive income to aircraft fuel expense on settlement of the derivatives. A loss of $14 million was reclassified from other comprehensive income to aircraft fuel expense in 2019 (net fuel hedging loss of $36 million in 2018). No hedge ineffectiveness was recorded during 2019 and 2018. There were no outstanding fuel derivatives as at December 31, 2019 and December 31, 2018.

  1. Discuss the Call option position/strategy
  2. Prepare the Journal entry for the settlement of the call option in the year.

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