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FRM Part I · FRM Exam Part I · Futures Markets

A company hedges a forecast sale of 100,000 barrels of oil with short futures. The spot price falls by 6 per barrel and the futures price falls by 5 per barrel over the hedge period. Assuming a hedge ratio of 1 with 100,000 barrels of futures, what is the net effective change in the company's position, and what is the best description of the remaining risk?

The company loses 600,000 on the physical oil but gains 500,000 on the short futures, leaving a net loss of 100,000. This residual arises because spot moved 1 per barrel more than futures, which is basis risk.

  1. AA net loss of 100,000 from basis risk, as the unhedged 1 per barrel move remainsCorrect
  2. BA net gain of 100,000 because futures gains exceed spot losses
  3. CNo net change because futures perfectly offset spot price moves
  4. DA net loss of 600,000 because the hedge fails entirely

Explanation

Spot loss is 6×100,000 = 600,000 on the physical position; futures gain on the short is 5×100,000 = 500,000. Net loss is 100,000, arising from the basis change (spot fell more than futures), so basis risk. The options claiming perfect offset or net gain ignore the difference; 600,000 ignores the futures gain.

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