An oil producer has an obligation under an agreement to supply 75,000 barrels of oil every month for one year at a fixed price. He wishes to hedge his liability to address the event of an upward surge in oil prices. The producer has opted for a stack and roll hedge rather than a strip hedge. Which one of the statements below is not wrong?
I. A strip hedge tends to have wider bid-ask spreads as compared to a stack & roll hedge.
II. A strip hedge increases transaction costs owing to active trading each month.
A. I only.
B. II only.
C. I and II.
D. Neither.
Answer: A
Explanation:
A strip hedge involves hedging a stream of obligation by offsetting each individual obligation with a futures contract matching the maturity and quantity of the obligation. A strip hedge tends to have lower liquidity and wider bid-ask spreads owing to longer maturity contracts.
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