Question One

$(20$ marks

a$)$ Clearly distinguish between a "short hedge" and a "long hedge"

$(5$ marks$)$

b$)$ PenPenny is a purchaser of oil and is due to take delivery of $5,000,000$ liters in January. In order to hedge against the possibility of oil prices increasing over the period up to January, the company takes a long position in a March futures contract. At the time, the price of March futures contracts is $$14\mathrm{.}50$ per $1,000$ liters, with each contract being for delivery of $1,000,000$ liters. In January the contract is closed out, with both the spot price of oil and the March futures being $$14\mathrm{.}75$ per $1,000$ liters.

Required: Calculate the transactions involved. How effective is this strategy in hedging the risk? Give reasons for your answer.

$(10$ marks$)$

d$)$ What are the costs of hedging?

$(5$ marks$)$

$($Total $20$ marks$)$