J&L RailRoad Case Study Answer | Hedging Commodity Price Risk

Case Study J and L RailRoad  Hedging Commodity Price Risk

Question 1

Should J&L hedge all of its exposure to diesel fuel for the ensuing year?What percentage of the 210 million gallons would you hedge?

Question 2

What are the pros and cons of using NYMEX contracts versus using the risk-management products offered by KCNB? Is the use of a monthly average price a net advantage or disadvantage to J&L? What about the bank?

Question 3

Using the estimate of 17.5 million gallons per month, how would you construct a futures hedge for the next 12 months? How would you construct a commodity-swap hedge?

Question 4

Should Matthews use a cap as a hedge? What strike price for the cap would you recommend she choose?

Question 5

If Matthews wants to minimize the cost of hedging, should she use a collar?What cap and floor strike prices would you recommend using?

Preview 

The main problem that Matthews has is to recommend a hedging strategy to a divided board. As noted, the Chairman has reservations about implementing the hedging strategy. At the same time, we are told that the board deems a decrease in operating profit of 11% as unacceptable. We are also told how ineffective the use of non-derivative strategies has been in the past and the desire for J&L
Matthews also faces operational risk challenges since J&L lack practical experience in implementing a hedging strategy of this nature.