Gamma airlines is currently considering a) to fix the price for their future jet fuel purchases; and, b) fix the exchange rate for their future international receipts. As a financial advisor of the firm you have advised them:
1. for the first (a) to buy a future on crude oil (cross-hedging)
2. For the latter (b) you suggest a currency future.
Assuming Delta Airline is a USA based firm and it receives and pay in $. Explain to the board of directors using the above scenarios as an example that:
i. What are the costs of making a futures contract in terms of settlement, delivery for both events if price fell below the agreed price and rise above the and who guarantees the fulfilment of contracts?
10 Marks
ii. How cross hedging will enable the firm to fix the price for jet fuel.
05 Marks
iii. Explain the uses of futures for speculating and arbitraging activities. Given the efficient market hypothesis why the chances of making arbitrage profits are said to be rare.
