Question

3. After May 2020 collapse of the futures oil markets, what are the prospects of futures contracts as a significant risk management tool for firms? Discuss critically.

Answer 1

Even after the May 2020 collapse of the futures oil markets the prospects of future contracts as a significant risk management tool for firms remain strong and robust.

It should be noted that the May 2020 collapse of the futures oil markets occurred due to weak global cues. The weak global cues, in turn, were due to the macro and micro economic factor disturbances caused by the corona pandemic. This scenario is a highly unusual scenario and the events of lockdown all across the globe and shutting down of industries reduced the demand for oil in most of the countries in which lockdowns were clamped to control the spread of corona virus. Amidst low demand the participants trimmed their positions and this led to fall in crude oil futures.

As mentioned earlier the situation caused by the corona pandemic is an anomaly and is an aberration. Hence despite the collapse of the futures oil markets in May 2020 we cannot discount the importance of future contracts as a significant risk management tool for firms. Future contracts are complex derivative instruments that will continue to systematically manage risk in the global financial market that derive their value from the underlying asset. Future contracts can be used to mitigate the risk of adverse price movements and investors should be aware of the fact that the risks can never be reduced to zero or can never be eliminated completely.