6. Case Studies (Real-World Applications)
Case Study 1: Exporter Using Forward Contract
Situation:
A Malaysian exporter will receive USD in 3 months and fears currency depreciation.
Strategy:
- Enters a forward contract to lock exchange rate
Outcome:
- Currency weakens → protected
- Currency strengthens → misses extra gain
Insight:
Forwards provide certainty in cash flows.
Case Study 2: Gold Investor and Cost of Carry
Situation:
An investor observes that futures price is higher than current gold price.
Explanation:
- Includes interest + storage cost
Insight:
Futures price reflects total holding cost over time.
Case Study 3: Airline Fuel Hedging (Futures)
Situation:
Airline wants to manage fuel price volatility.
Strategy:
- Uses futures contracts
Outcome:
- Price rises → gains in futures offset higher fuel cost
- Price falls → loses in futures but benefits from cheaper fuel
Insight:
Hedging reduces uncertainty, not total cost.
Case Study 4: Basis Risk in Hedging
Situation:
A company hedges using futures, but spot and futures prices do not move perfectly together.
Result:
- Hedge is not perfectly effective
Insight:
This difference is called basis risk—a key limitation of hedging.
7. Key Concept: Basis
Basis = Spot Price – Futures Price
Important points:
- Basis changes over time
- Perfect hedging is rare
- Managing basis risk is part of real-world strategy
8. Strategy Summary
| Strategy | Purpose | Instrument |
|---|---|---|
| Long Hedge | Protect against price rise | Buy futures |
| Short Hedge | Protect against price fall | Sell futures |
9. Key Takeaways
- Forward and futures prices are based on cost of carry
- Hedging reduces risk but does not guarantee perfect outcomes
- Basis risk is an important real-world consideration
- Forwards offer flexibility; futures offer liquidity and lower risk
10. Quick Practice
Scenario:
A company needs to purchase oil in 4 months. Prices are expected to rise.
Question:
- Should it use a forward or futures contract?
- What factors influence the price it locks in?