2007 Commodity Risk Management-1

2007 Commodity Risk Management-1 - Commodity Risk...

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1 Commodity Risk Management
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2 Physical Contracts Volume Types Firm - seller or buyer has legal recourse if volume not delivered or taken Interruptible or Swing - seller nor buyer obligated Key Terms of Contract buyer seller price quantity receipt/delivery point/title transfer point time terms and conditions
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3 Energy components of floating prices or fixed prices Index Reference Point such as NYMEX “Henry Hub” for Natural Gas WTI (West Texas Intermediate-Cushing) or Brent for Crude Oil plus Basis or Location Differential from Index Pricing Point Any or all components can be fixed or floating.
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4 Financial Market Terminology Derivative : A Trading Instrument: Value is determined from one or more physical commodities and/or financial securities underlying the derivative. Underlying Commodity or Security : The physical commodity or financial security from which a derivative obtains its value.
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5 Leverage : The effect of magnifying the outcome of an investment through use of borrowed funds. Example: Price at Purchase = 100 Price at Sale Year Later = 120 Equity % Gain = 20% Unlevered Gain = 20% If borrowed 50% at 10% Interest Gain = 120 - 100 - 5 = 15 Original Equity Investment = 50 Equity Gain % = 30%
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6 Hedging : In general, the term hedging is used when describing entering a transaction with the intent of offsetting risk from another related transaction. Examples: insurance for fire, business interruption In commodities and securities markets, a hedge is a transaction entered into for the purpose of protecting the value of a commodity or security from adverse price movement by entering an offsetting position in a related commodity or security.
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7 Futures Contracts : Standardized: Each contract represents the same quantity and quality of the underlying physical
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2007 Commodity Risk Management-1 - Commodity Risk...

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