MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS, HOCHIMINH CITY

INTERNATIONAL SCHOOL OF BUSINESS
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DERIVATIVES FIN 202

ASSIGNMENT
Release Date: 9AM Wednesday 12/7/2023
Due Date: 8AM Monday 31/7/2023.

Instructions:
Please read and follow these instructions closely.

• This is a group assignment. You are not allowed to share your work with people
outside your group.

• This assignment consists of two sections which are of equal value.

• For the first section, each group will submit a typed-written report which contains
all the solutions, calculations, diagrams, analysis. The first page of the report
should be the cover page which includes the names and detailed contribution of
all group members. The data file required for the analysis is attached with the
assignment.

• For the second section, each group will submit a pre-recorded 15-minute pre-
sentation on one of the listed topics. Some groups will be randomly selected
for live presentation on 31/7/2023. A representative from each group will com-
municate to the lecturer the group’s chosen topic. Since each topic can only be
presented by at most one group, topics will be claimed on the first come, first
served basis. The notes for the presentation need to be submitted along with the
report.

• Please report to the lecturer any group members who are not doing their fair share
of work. Members of the same group do not necessarily get the same marks.

• Deadline should be strictly adhered to. Late submissions of the report will be
penalized at 10% per day. Late submission of the pre-recorded presentation will
result in an automatic zero.

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Section 1: Hedging Fuel Costs for Dragon Airlines

Background
Dragon Airlines (DA) specializes in offering chartered flight services in Southeast Asia.
Its jet fuel consumption of the financial year 2021-2022 was 4.5 millions gallons. Its
consumption for the 2022-2023 financial year is projected to be 5% higher.
DA buys its jet fuel quarterly in advance. For example, at the end of June 2023,
DA buys a quarter of its projected fuel consumption to be used between July and
September 2023. For simplicity, we ignore the storage costs and convenience yields of
jet fuel.
As a financial analyst hired by DA, you need to plan a strategy executed on
12/7/2023 to hedge the September-end, December-end and March-end purchasing costs
by trading listed futures on oil-related products such as crude oil and natural gas. DA
is interested in minimizing the variance of its net amount spent on jet fuel.
For example, to hedge its September-end purchasing cost, DA takes a position
on 12/7/2023 in the futures contract that mature in December 2023. At the end of
September, DA purchases its jet fuel on the spot market and at the same time closes
its position in the futures maturing in December 2023.

Questions
1) Investigate the correlations between the jet fuel spot prices and futures prices of
crude oil and natural gas for the September-end data. You should support your
analysis with appropriate diagrams and calculations.

2) Repeat the investigation in part 1) for December-end and March-end data.

3) How many contracts of crude-oil futures or natural gas futures do you need to
trade if you want to hedge the September-end purchasing cost of DA ? Calculate
the variance of the hedged portfolio. Which type of contracts would be more
appropriate for DA’s objective ?

4) Repeat the analysis of part 3) for the December-end and March-end purchasing
costs.

5) Suppose that you are allowed to trade in both crude-oil and natural gas futures.
How many contracts do you need to trade in each to hedge the September-end
purchasing cost of DA ? Calculate the variance of the hedged portfolio. Compare
your answer to that of part 1).

6) Repeat the analysis of part 3) for the December-end and March-end purchasing
costs.

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 7) Suppose DA also wants to explore trading options on jet fuel as an alternative
to trading futures. Suggest at least 3 appropriate trading strategies involving
options.
8) Sketch a graph for the quarterly spot prices of jet fuel. Calculate the historical
volatility of jet fuel.
9) Assume the Black-Scholes-Merton model is applicable. Suppose the risk-free in-
terest rate is 3% and that the jet fuel spot price is $2.15. Calculate the values of
a European call and a European put on 12/7/2023 for 1 gallon of jet fuel at $2.15
which mature on 30/9/2023. You should use the historical volatility in part 8).
10) Use the binomial tree method with 50 periods to find the values of the corre-
sponding American call and put options for those of part 9).
11) Compare and contrast the use of futures and options to achieve DA hedging
objectives.

Section 2: Presentation
List of topics:
1. Interest Rates Futures - Suggested reference: Hull 2016, Chapter 6.
2. Swaps - Suggested reference: Hull 2016, Chapter 7.
3. Securitization - Suggested reference: Hull 2016, Chapter 8.
4. Futures Options - Suggested reference: Hull 2016, Chapter 16.
5. Volatility Smiles - Suggested reference: Hull 2016, Chapter 19.
6. Exotic Options - Suggested reference: Hull 2016, Chapter 22.
7. Credit Derivatives - Suggested reference: Hull 2016, Chapter 23.
8. Portfolio Insurance - Suggested reference: R. Bird and M. Tippett, Portfolio In-
surance, what is it and how is it implemented ?
9. Case Study: Long Term Capital Management - Suggested reference:
https://www.bauer.uh.edu/rsusmel/7386/ltcm-2.htm
10. Case Study: Metallgesellschaft - Suggested reference:
https://www.e-education.psu.edu/ebf301/node/571

—————–END OF ASSIGNMENT—————–