Suppose a dealer is receiving the floating rate and paying t

Suppose a dealer is receiving the floating rate and paying the fixed rate in a 2-year commodity swap. The dealer could best hedge this position by taking...

a. long positions in the 1-year and 2-year forward contracts on this commodity.

b. a short position in the 1-year forward contract, and a long position in the 2-year forward contract

. c. a long position in the 1-year forward contract, and a short position in the 2-year forward contract.

d. a short position in the 2-year forward contract only. e. short positions in the 1-year and 2-year forward contracts on this commodity.

Solution

Correct option :

d. a short position in the 2-year forward contract only. e. short positions in the 1-year and 2-year forward contracts on this commodity.

a) is not applicable as it shall be similar to paying the fixed rate in a 2-year commodity swap

b) is not applicable as long position shall not cross out the risk of rising price in year 2

c) is not applicable as again long position shall not cross out the risk of rising price in year 1