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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

Metallgesellschaft Refining and Marketing (MGRM) sold long-term fixed-price fuel delivery contracts and hedged them mainly with short-dated energy futures that were rolled forward. Which feature of this strategy most directly created the funding liquidity problem when oil prices fell sharply in 1993?

The funding problem arose because falling oil prices produced immediate cash margin calls on MGRM's short-dated futures hedges, while the offsetting economic gains on its long-term fixed-price customer contracts were unrealized and could not be used to meet the calls, creating a cash-flow timing mismatch.

  1. AMargin calls on losing futures positions required immediate cash, while the offsetting gains on the fixed-price customer contracts were unrealized and not available as cashCorrect
  2. BExchanges raised the credit rating requirements for MGRM, which forced it to unwind its customer contracts
  3. CThe long-dated customer contracts were marked to market daily, producing immediate cash outflows
  4. DMGRM had hedged with long-dated swaps whose counterparties demanded early termination payments

Explanation

MGRM was long short-dated futures against short long-dated fixed-price forward commitments. When prices fell, futures losses were settled in cash through variation margin, but the gains on the customer contracts accrued only over years. The mismatch in cash timing created the funding strain. The daily marking of customer contracts did not occur.

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