In June 2020, a US Airline company hedges the cost of purchasing 2,000 barrels of oil planned in November 2020 by entering into December 2020 futures contracts. The price of the futures contract in June was USD40 when the spot price was USD37. Each contract is for delivery of 1,000 barrels.

Answer ALL of the following:

1. Describe and explain the firms natural position with respect to oil prices and how it can use the futures market to hedge its financial risk.

2. In November 2020, the futures price is USD45 and the spot price is USD44. Calculate the basis in USD for June and November.

3. Calculate the unhedged payoff to the company in USD and its effective purchase price expressed in USD per barrel. Explain how effective the hedge is and discuss the reason for any hedge error.