Welcome to the hedge simulator

Because of one lucky shot in your last golf game with the CEO, you have just been appointed chief financial officer for a major airline and discovered that one of your largest expenditures, one that is changing constantly and could potentially bankrupt your firm, is the cost of jet fuel. Your airline has a constant� demand for fuel of 100000 barrels/week and the price of a barrel changes weekly, going up by $1.00 with probability �� or going down with probability 1/2 . (It never stays the same two weeks in a row).� The current price is $60/barrel, so it looks like the price should average around $60.� If the average over the next year is greater than $63,� the CEO has kindly informed you (on the 17�th hole)� that the airline will lose money and, worse luck, you will lose your job unless you can find a way to� shelter the company against this increase in price.

What is the probability that you are fired?�

What if you buy an option or �price guarantee� which guarantees to make up the difference, if any, between the average price per barrel for the year and� the guarantee price. For example if you pay me an insurance premium of about $0.87�� per barrel for a guaranteed price of $62, then if the average price over the year exceeds $62,� I will pay you the difference.

�� price�� premium

�� 61.0000�� 1.2400

�� 62.0000�� 0.8700

�� 63.0000�� 0.5900

�� 64.0000�� 0.3900

�� 65.0000�� 0.2400

�� 66.0000�� 0.1400

�� 67.0000�� 0.0800

�� 68.0000�� 0.0400

�� 69.0000�� 0.0200

�� 70.0000�� 0.0100