Question 11-3

THE LOGIC OF HEDGING WITH OPTIONS Morrison Oil and Gas Companys (from Problem 11-1) chief financial analyst is Samuel (Sam) Crawford. Sam completed his analysis, suggesting that the investment is indeed a good one for the company, and presented it to the firms executive committee. The executive committee consists of the firms CEO, CFO, and COO. The CFO thought Sams analysis was on target, but the COO and CEO were concerned about the fact that the hedging strategy would not work for the investment. In fact, they wondered why hedging the investment is such a good idea. Sam thought for a second or two before responding and decided how to best explain why the project is a good one and involves hedging the investment cash flows using one-year call options on natural gas. These call options, which have a $13.90-per-MCF strike price, are selling for $1.86 per MCF. Show how selling call options on 50 MCF of gas today and undertaking the investment provides Morrison with a hedged (i.e., risk-free) investment. Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 423). Prentice Hall. Kindle Edition. Hi you did such a great job of answering my question last week I have another.