CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
An airline wants to protect against a rise in jet fuel prices but also wishes to retain the benefit if fuel prices fall, and is willing to pay an upfront cost. Which instrument is the most appropriate?
A long call option on fuel is most appropriate. It sets a ceiling on the fuel cost if prices rise, while the airline still benefits when prices fall, and the price of this flexibility is the upfront premium. Swaps and futures lock in prices and remove the benefit.
- ALong call option on fuelCorrect
- BShort fuel futures contract
- CPay-fixed fuel swap
Explanation
A long call caps the purchase price while keeping the benefit of lower prices, at the cost of a premium. A short futures position would lose when prices rise, adding exposure. A pay-fixed swap locks in the price and gives up the benefit of price declines.
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