In each of the following, the counterparties enter forward crude oil contracts on June 10. Your job is to write the steps that will be taken by the parties on the forward contract settlement date. Notice I provide three worked out examples. Follow that pattern.

Crude oil is $50/barrel in the spot market on June 10.

Consider four entities who will make use of the forward contracts:

• Oil producer who will sell crude oil and desires to hedge against a price decline.

• Oil refiner who will buy crude oil and desires to hedge against a price increase.

• Speculator A who believes crude oil price will rise.

• Speculator B who believes crude oil price will decline.

Contract: 10,000 barrels of crude to be delivered, or cash-settled, July 15 (settlement date)

Counter-parties enter contracts on June 10 at settlement price of $51/ barrel

SPOT PRICE OF CRUDE ON SETTLEMENT DATE TURNS OUT TO BE $55/BARREL

I Oil refiner goes long physical delivery contract June 10.

1. On July 15, pays $510,000 to contract counterparty who went short.

2. Receives 10,000 barrels of crude from counterparty.

Refiner locked-in the $51/barrel purchase price

II Oil producer goes short physical delivery contract June 10.

1.

2.

Producer locked in . . .

III Speculator A goes long physical delivery contract June 10.

1.

2.

3.

4.

5.

Speculator A profits . . . .

IV Speculator B goes short physical delivery contract June 10.

1. Buys 10,000 barrels in the spot market July 15 for $55/barrel

2. Receives 10,000 barrels from spot market seller

3. Pays $550,000 to spot market seller

4. Delivers 10,000 barrels on July 15 to contract counterparty who went long

5. Receives $510,000 from counterparty

Speculator B loses $4/barrel, or $40,000

V Oil refiner goes long cash settled contract June 10.

1.

2.

3.

4.

Net cost to refiner is . . . Hence . . .

VI Oil producer goes short cash settled contract June 10.

1. Sells 10,000 barrels in the spot market July 15 for $55/barrel

2. Delivers 10,000 barrels to spot market buyer

3. Receives $550,000 from spot market buyer

4. Pays $(55-51)x10,000 = $40,000 to forward counterparty who went long

Net revenue to producer is $510,000. Hence, producer locked-in the $51/barrel purchase price

.

VII Speculator A goes long cash settled contract June 10.

1. Receives $(55-51)x10,000 = $40,000 from forward counterparty who went short

A profits $4/barrel, or $40,000

VIII Speculator B goes short cash settled delivery contract June 10.

1. .

B loses . . . .

SPOT PRICE OF CRUDE ON SETTLEMENT DATE TURNS OUT TO BE $48/BARREL

IX Oil refiner goes long physical delivery contract June 10.

1.

2.

Refiner locked-in . . .

X Oil producer goes short physical delivery contract June 10.

1.

2.

Producer . . .

XI Speculator A goes long physical delivery contract June 10.

1.

2.

3.

4.

5.

A loses . . . .

XII Speculator B goes short physical delivery contract June 10.

1.

2.

3.

4.

5.

B . . .

XIII Oil refiner goes long cash settled contract June 10.

1.

2.

3.

4.

Net cost to refiner is

XIV Oil producer goes short cash settled contract June 10.

1.

2.

3.

4.

Net revenue to producer is

.

XV Speculator A goes long cash settled contract June 10.

1.

A loses . . .

XVI Speculator B goes short cash settled delivery contract June 10.

1.

B profits . . .