Question

In Metallgesellschaft's Hedging Debacle the company arranged long term forward contracts to sell oil/energy. Their hedge was to sell short-term futures contracts and roll into new months(called a stacked hedge). The hedge turned out poorly for MG because the stacked hedge works when markets are in backwardation and the basis risk resulted in negative profit between the selling the futures and delivering in the forwards. What is true about the activities of Metallgesellschaft's hedging

I. sources of risk were basis risk and liquidity risk
II. losses on the short term futures contracts hedge would not be covered by the long term forwards
III. the stacked hedge works when markets are in contango
IV. Metallgesellschaft used a 1 to 1 hedge when they should have used an optimal hedge ratio

a. I, II, III, IV
b. I, II, IV
c. I, III
d. I, III, IV

Answer 1

Answer:

The truth about the activities of Metallgesellscraft's hedging was:

b. I, II, IV.

Explanation:

Hedging financial risks involve the strategic use of financial instruments to offset the risk of any adverse price movements.  Hedging provides security traders and investors the means to mitigate market risk and volatility and minimize future financial loss.  The stacked hedge, in which the most nearby and liquid contract is used and then rolled over to the next-to-nearest contract as time passes, works when the markets are in backwardation (lower forward price than the spot price) and not in contango (higher forward price than the spot price).