Study Questions
As the financial analyst, you have already provided Burns with several risk management strategies. Based on the information provided in the case for July natural gas futures, what type of futures option would result in the most profitable hedging strategy? Explain. Support your answer. What characteristics of futures options make them beneficial to companies such as Burns Energy Associates? (view solution)
What effect does a floor have on price improvement strategies? Smithers has advised Burns to attach a floor to their futures option. Find the best among the floors using all three strike prices. Computations should include calculation of the premium and analyses of the minimum and current costs. (view solution)
Is it appropriate for Burns to use caps as a tool for risk management? Explain your answer. If so, find the best among the caps using all three strike prices (include the calculation of the premium and analyses of the minimum and current costs). (view solution)
Discuss why a company would profit from entering into a contract that is attached with a zero-premium collar? Find the best among the zero-premium collars for all three strike prices. Computations should include calculation of the premium and determining the maximum, current, and minimum costs. (view solution)
Evaluate the risks present in this case. (view solution)
Do these transactions qualify for hedge accounting? If so, what type? Justify your answer. (view solution)
Record the transactions as they would appear in the company's books. (view solution)
In light of the recent changes in accounting for derivatives, what effects do these transactions have on the financial statements? (view solution)
As a result of the increase in use of derivative financial instruments by companies today to mitigate risk, companies have found it difficult to portray the nature of these risks within the financial statements. Assume that these transactions are not recorded on the company's balance sheet. Discuss the drawbacks of this approach. Does this off-balance sheet risk exist within this case? What types of methods could a company use to aggregate and quantify its risk in the financial statements with respect to these types of transactions? What method would be the most beneficial for Burns? Explain. (view solution)
