Problem 14-24 Hedging Heating Oil with Futures (LO4, CFA5)

Heating oil futures contracts are traded on the New York Mercantile Exchange (NYM), a division of the CME Group. The standard

contract size for heating oil futures is 43,500 gallons per contract. You have an inventory of 1.740 million gallons, and you want to

construct a full hedge. Suppose the average acquisition price of your 1.900 million gallons of heating oil is $1.90 per gallon and that

today's futures price for delivery during your heating season is $2.20. In the past, market conditions in your distribution area were such

that you could sell your heating oil to your customers at a price 40 cents higher than the prevailing futures price. To help finance your

inventory purchases, you borrowed money. During the heating season, you have to make an interest payment of $600,000. Calculate

the pretax profit for your enterprise in the cases shown in the spreadsheet without a hedge in place and with a hedge in place. (Leave

no cells blank - be certain to enter "O" wherever required. A negative value should be indicated by a minus sign. Do not round

intermediate calculations. Round your answers to 2 decimal places.)

Base Case: No Change Heating Oil Price Heating Oil Price in Heating Oil Price Decrease Increase 1,740,000 1,740.000 1.740.000 $ 2.45 s 2.05 $ 2.85 $ 2.05 2.05 $ 2.05 S 2.20 $ 1.80 $ 2.60 Heating oil inventory (gal) Selling price, per gallon Avg purchase price, per gallon Futures price Without a Hedge Revenue Cost of inventory sold Interest expense Pretax profit Pretax profit, per gallon With Short Hedge (short futures at $2.20) Contracts needed Revenue Cost of inventory sold Interest expense Futures gain (loss) Pretax profit Pretax profit, per gallon Futures gain (loss)per gallon