The tile for this assessment is: “Derivatives and oil price risk”. There are fo

The tile for this assessment is: “Derivatives and oil price risk”.
There are four parts that account for this assessment, these include:
1. Derivatives products for hedging oil price risk
2. Futures curves
3. Pricing crude oil futures options
4. Hedging oil price risk by governments
1) Derivative products for hedging oil price risk
In this activity we would like you to take a role of an Assistant of the Head of Risk Management Department in an international corporation that operates in oil and gas sector and belongs to a group of Integrated Oil&Gas companies. Uncertainty of the future price of oil is one of the major risks faced by the company.
Your manager has asked you to look through available derivative instruments (using online sources) at a selected stock exchange (of your own choice) and to briefly report on three most actively traded derivatives that would be suitable for hedging the oil price risk.
Prepare a mini-report and include the basic information about each derivative instrument. Specifically, include the following information:
– A brief explanation of the instrument and how it allows to hedge against the oil price risk
– Delivery details of the contract
– Required margins or collateral
– Available contracts and their codes
– Other relevant information
Please remember to state the exchange that you select, the date on which you gather the above information and explain how you identify the “most actively traded” derivative contracts.
The language of your report should be professional but sufficiently intuitive that it can be understood by someone who may have a vague idea about derivatives.
2) Futures curves
Your task here is to prepare the graph of futures curves for crude oil futures contracts at two different dates in the history.
– You can select the dates but they need to be at least 3 months apart from each other
– The future curve for each date needs to be based on at least 6 contracts and the time to delivery for those contracts should span from 1 month to at least 12 months (it would be preferable that the time to delivery is spanned more or less equally but this is not a necessary condition)
The data for the graph should be placed in the table (or tables) and you need to show clearly the following information in this table:
– The two dates for which the futures curves are prepared
– Time to delivery (in months)
– The futures contracts that were used for that purpose (codes or names that include the delivery month and year)
– The source of your data
You can obtain the relevant data from online sources such as financial web pages or financial services (for example: https://www.investing.com/, https://finance.yahoo.com/, https://www.marketwatch.com/, https://www.barchart.com/). You are free to select other online resources as well but you need to specify the source of your data and how you collect the data (e.g. hand collection or download data, in which case you need to attach the files with the downloaded data to your report).
Once you have the graph of futures curves for two different dates, we would like you to compare your graph with the one you can obtain here (https://www.erce.energy/graph/wti-futures-curve/historical-futures-curve-data) for the dates you selected. If the graphs are different, please explain the reasons for that difference.
Given your futures curves (and the one you obtained (https://www.erce.energy/graph/wti-futures-curve/historical-futures-curve-data/ ), discuss the situation in the oil market in the light of the theories you have learned about commodity futures price determination. In your discussion you should include the following elements:
1. Are oil markets in backwardation or in contango? What can you \”read\” from the futures curves given the relation between the cost of carry and the convenience yield for oil?
2. How are the backwardated and contangoed markets related to the Theory of Storage and Theory of Normal Backwardation?
3. In the light of your discussion on the previous two points, express your view on the implications of the aforementioned theories for oil market and the reality that you observe from the crude oil futures curves.
3) Pricing crude oil futures options
In this part we would like you to build the three-step binomial tree for American futures options for crude oil and price those options using the equivalent binomial model. Please use the hedge portfolio approach to price the American call futures option and risk neutral valuation to price the equivalent American put futures option.
For the purpose of the above task consider a hypothetical option that expires in one year and has a strike price 10% greater then the current futures price. Consider also the case when the futures contract expires two days after the option expiration date and this interval can be perceived as negligible for the purpose of a quantitative analysis in this exercise. Assume that the annualised volatility of one-year crude oil futures price is 45%.
You also need to source online the other inputs for the binomial model, that is:
– The current futures crude oil price of the underlying contract
– The one year risk free interest rate
For the selected values of the above parameters, you need to report the source of the data, the date of collection and provide a screenshot of the online source.
Prepare the binomial model for both options and conduct the relevant quantitative analysis in an Excel spreadsheet.
Describe also the process for obtaining the value of the option at a particular node for each of the two options. For the call option, clearly explain the replication strategy, the assets involved in the strategy and which positions are taken in the relevant assets. You should demonstrate here your practical ability to apply the binomial model in futures option valuation.
Once you obtain the prices for American call and put futures options from the binomial model, we would like you to use Black’s model to compute the prices of European call and put futures options. Can you use Black’s model to price American futures options? Explain how are the prices of the European and American futures options are related to each other.
Any explanation and discussion in this task should not be included in the excel spreadsheet, but in the research report.
4) Hedging oil price risk by governments
In this part we would like you to read the following research papers:
“Hedging government oil price risk” by James A. Daniel, The Journal of Energy and Development 27(2), pp 167-178, published in 2002.
“Managing oil price risk in developing countries” by Julia Devlin and Sheridan Titman, The World Bank Research Observer 19(1), pp 119-140, published in 2004.
After reading the papers, please critically address the following discussion topic:It is now a common practice among the oil and gas companies to use derivatives in order to hedge oil price risk. This is, however, not the case for governments of the countries in which the oil industry is one of a major GDP contributor.
Can you give the reasons, and critically assess why relevant governments do not use available derivative instruments to manage oil price risk?
Discuss the benefits of using market-based derivatives for hedging oil price risk for the governments and through that, for society.
Explain your views on the current development and state of the derivatives markets (both exchanges and OTC) for appropriate management of oil price risk by governments? Substantiate your opinion in the light of the reasons aforementioned in the first point.
Your answers and solutions to the above four parts should be placed in a research report.
The suggested word count for each subsection in the main body:
Derivatives products for hedging oil price risk: 400 words
Futures curves: 350 words
Pricing crude oil futures options: 250 words
Hedging oil price risk by governments: 500 words
In total your report should have 1500 words +/-10%.
Note that equations, tables, titles, footnotes, comments in the Excel spreadsheet, and the abstract are not included in the word limit. Please include a word count at the end of the report. There should be an Excel spreadsheet attached to your report, related to part three of this assessment.