Question #15
Reading: Reading 32 Introduction to Commodities and Commodity Derivatives
PDF File: Reading 32 Introduction to Commodities and Commodity Derivatives.pdf
Page: 5
Status: Correct
Correct Answer: A
Question
An oil refiner wants to hedge oil price risk using a swap. The swap pays the oil price above $50 per barrel in exchange for a fixed price of $1 per barrel. The notional principal is 1 million barrels. If the refiner enters the swap, the total profit to the refiner if the price of oil is $52 is closest to:
Answer Choices:
A. –$2,000,000
B. +$2,000,000
C. +$1,000,000
Explanation
An oil refiner would be concerned about oil prices rising (i.e. input costs going up) and
hence would hedge their exposure by choosing to receive the return on oil (i.e., the
difference between the market price and $50) and pay the fixed $1. In this instance the net
payoff is ($52-$50)-$1 = $1 per barrel (recall that the notional is 1 million barrels).