Commodities are a large and important component of the global economy. The focus of this class is why commodity-producing companies may want to strategically hedge their commodity price exposures in the futures and options markets. Commodity producers generally want to hedge so they can free up their capital and put it to more interesting uses like expanding their companies.
We will spend considerable time exploring a model for the optimal hedging behavior of commodity producing companies. In particular, after reading the relevant research paper that describes a model of the economics of strategic hedging, we will re-derive the model and its implications, add a second commodity exposure to the model to expand its usefulness, and implement multiple versions of it in excel.
In practical terms, you will need to be able to follow reasonably complex algebraic equations. I’ll do some calculus in the derivations. You will need to be able to interpret the economic significance of the resulting relationships and apply them to practical problems. You will also need to be able to apply the model to problems and calculate the producers’ optimal hedge ratios.
We will hear from two or three industry experts. We will also briefly cover strategic investments in commodities by institutional investors, which turn out to be directly related to producer hedging. We will also briefly cover physical commodities and how the futures markets work, including forward curves, margins, and trading exposures. Through a paper-based futures trading contest, you will gain first-hand experience with the futures markets.