Jamaica Oil Company wants to finance its working capital inventory of oil using hedging techniques. The current 30-day price of oil on the futures market is US$66 per barrel and the spot price is US$72.

The outlook for the price of oil is for it to fall in the near future. The forward contract for oil in the next month is US$70. The company needs to purchase 2 million barrels of oil at the end of next month to satisfy its inventory requirement. The prices of ExonMobils stock over the last five days were US$110, US$112, US$108, US$106 and US$105. The 30-day price on a call option on ExonMobils stock is US$3 per stock.

Required:

1. Explain the principles of hedging. (10 marks)
2. Determine what is the best option for Jamaica Oil Company in acquiring next months inventory of oil. (10 marks)