Question

Unioil produces vegetable based cooking oil and butter spreads. Unioil uses large quantities of crude palm oil (CPO)in its production process as a main raw material. It is September 2020 now and Unioil estimates a need of 25,000 metric tons (MTs)of CPO in March 2021. Current spot price of CPO is RM2200 per MT. You as the procurement manager of Unioil, have the following alternatives to hedge the possible increase in the CPO price by March 2021:

1. The commodities analysist predicts that the CPO will be trading at RM3400 per MT in March 2021

2. Forward contracts on CPO for March 2021 delivery is available at RM3600 per MT.

3. March 2021 Futures contract on CPO (FCPO) is available and currently trading at RM2280 per MT. (FCPO has a contract specification of 25 metric tons per contract). What would be your net purchase price in March 2021 if the CPO closing price in March 2021 is RM3500 per MT? Justify whether this is a perfect hedge?

4. European Options on March 2021 CPO is available at the following prices:

March 2021 Strike RM/MT	European Call March 2021	European Put March 2021
3300	200	120
3400	190	140
3500	180	150
3600	160	180
3700	140	200

You are required to evaluate each hedge alternative carefully and suggest the best hedge strategy or would you decide to remain unhedged. Your answer should include a careful cost and benefit analysis for each hedge alternative and justify your selection in terms of its certainty and effectiveness.

Answer 1