Answer :
The hedge was effective in mitigating the risk of price fluctuations in the NG market. To analyze the hedge and determine its success.
We need to create a time table that includes relevant information such as contract dates, spot market prices, futures amount, and the corresponding calculations. On November 11, 2021, firm XYZ had a contract to buy 1 million units of Natural Gas (NG) on February 15, 2022. Since one NG futures contract on NYMEX covers 10,000 NG units, the firm decides to use a hedge ratio (h) of 1, meaning they will need 100 futures contracts to hedge their position.
On November 11, 2021, the spot market price of NG was $4.95 per unit, and the futures price for the MAR 2022 contract was $4.65 per unit. With these prices, the firm enters into a hedge by buying 100 MAR 2022 NG futures contracts. On February 15, 2022, the actual spot price of NG turned out to be $4.50 per unit, while the futures price for the MAR 2022 contract on that day was $4.40 per unit. To analyze the effectiveness of the hedge, we need to calculate the gains or losses from the spot market position and the futures position. For the spot market position, the firm bought 1 million NG units at a spot price of $4.50 per unit. Therefore, the total cost of the spot market position is $4.50 million.
For the futures position, the firm bought 100 MAR 2022 NG futures contracts at a futures price of $4.65 per unit. However, on February 15, 2022, the futures price dropped to $4.40 per unit. The loss on the futures position can be calculated by multiplying the change in futures price by the number of units covered by the futures contract and the number of contracts. In this case, the loss on the futures position is ($4.40 - $4.65) * 10,000 * 100 = -$250,000. Overall, the firm incurred a loss of $250,000 on the futures position but gained $4.50 million on the spot market position. Considering the initial contract to buy 1 million NG units, the firm successfully hedged its position as the gains from the spot market position offset the losses from the futures position.
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