J&L Railroad

1158 WordsMay 17, 20125 Pages
1. J & L should hedge only some of its exposures to diesel fuel. Although there are several financial instruments available for J & L to hedge against the risk of rising diesel fuel prices, these instruments still have their own downsides and possibly their own risks. For example, the future contracts from NYMEX seems like an effective hedging strategy for J &L, but there are some difficulties in terms of using futures from NYMEX to hedge against the diesel prices. NYMEX does not trade contracts on diesel fuel, so it was not possible to hedge diesel fuel directly. Heating oil and diesel fuel, however, are highly correlated in market prices (.99 correlation). Thus, J & L can use heating oil to hedge. But what if there is a…show more content…
On the mature date in July, no matter what the market price is, J&L only has to pay $1.4638/gallon. It faces no uncertainty about the net price paid after entering a futures hedge. Commodity swap is a swap in which exchanged cash flows are dependent on the price of an underlying commodity. Commodity swap is usually used to hedge against the price of a commodity. for example, a company that uses a lot of oil might use a commodity swap to secure a maximum price for oil. In return, the company receives payments based on the market price (usually an oil price index).On the other side, if a producer of oil wishes to fix its income, it would agree to pay the market price to a financial institution in return for receiving fixed payments for the commodity. This is how J&L could use a commodity-swap hedge as a heavy diesel user. 4. A cap is one of the commodity options that KCNB offered to J&L to hedge against the price fluctuation risk. For a cap, KCNB agreed to pay the excess of the realized average fuel price over the cap’s strike price. If the average fuel price never reached the strike price, KCNB would pay nothing. As for any option, J&L would need to pay KCNB a premium for the cap. I would recommend S&L choosing the strike prices closet to the expected price. That means J&L will be carrying the least risk as possible
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