Question

Midwest Airlines is short 2 million gallons of jet fuel. Since no jet fuel contract exists, they decide to hedge with crude oil futures. One 42 barrel of crude oil is needed to produce 20 gallons of jet fuel. If one contract is for 1,000 barrels, how many crude oil contracts will they need to properly hedge their exposure?

A) 2,000 contracts

B) 4,200 contracts

C) 20 million contracts

D) 42 million contracts

We were told answer is (B) 4,200 contracts but I do not understand the calculations.

Answer 1

Given information- Midwest airlines are short of 2 million gallons of jet fuel

42 barrel of crude oil = 20 gallons of jet fuel

1 contract = 1,000 barrels

Find- Number of crude oil contracts

Here, they need to short 2 million gallons of jet fuel contracts but as they are not available, they will have to hedge against crude oil contracts.

If 42 barrel of crude oil = 20 gallons of jet fuel

then? = 2 million gallons of jet fuel

cross multiplying the above we get,

2 million x 42 / 20

= 4,200,000 barrel of crude oil

As 1 contract = 1000 barrel,

we will require 4,200,000/ 1000 contracts of crude oil.

=4200 contracts of crude oil.

Hence, Midwest airlines will need 4,200 crude oil contracts to hedge their exposure properly.