Corporate Strategies to Hedge Commodity Price Risks Applying Derivatives

Table of contents
List of abbreviations III
List of figures III
List of tables III
1 Introduction 1
1.1 Problem and objective 1
1.2 Structure of this paper 1
2 Background Information 2
2.1 Definitions of fundamental terms 2
2.2 Commodity price risk in different firms 2
3 Explanation of derivatives 3
3.1 Options 3
3.2 Futures 4
3.3 Forwards 6
3.4 Swaps 6
4 Hedging strategies with derivatives 7
4.1 Hedging with options 7
4.2 Hedging with futures 7
4.3 Hedging with forwards 8
4.4 Hedging with swaps 8
5 Pros and cons of hedging strategies with derivatives 8
5.1 Pros and cons of options 9
5.2 Pros and cons of futures 9
5.3 Pros and cons of forwards 10
5.4 Pros and cons of swaps 10
6 Practical example of corporate commodity price risk hedging 10
6.1 Introduction on firm's practical hedging strategy 10
6.2 Analysis on this strategy 11
7 Summary 12
Appendix 13
Appendix 1: Amounts outstanding of over-the-counter (OTC) derivatives by risk category and instrument——in billions of US dollar 13
Appendix 2: Derivatives financial instruments traded on organized exchanges by instrument and location——in billions of US dollar 14
Bibliography 15
Internet Source 16 List of abbreviations
CH Clearing House
IM Initial Margin
MB Margin Balance
MM
N Maintenance Margin
No
OTC Over The Count
VM
Y Variation Margin
Yes

List of figures
Figure 1: Structure of this paper 2
Figure 2: P&L of each option position 4
Figure 3: Flow chart of marking-to-market process 5
Figure 4: P&L of each future position 6
Figure 5: Hedging model on fuel oil of Air China 11

List of tables
Table 1: Summary for 4 option positions 4
Table 2: Summary for future positions 6
Table 3: Summary for 4 derivatives 9

1 Introduction
1.1 Problem and objective
The risk of commodity price is a ferocious topic in corporate operation. Corporate profit is equal to total revenue minus total cost. For firms, because of the high volatility