exercise_topic_03 - The notorious case of the Hunt...

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UNIVERSITY OF ESSEX DEPARTMENT OF ECONOMICS Session 2011–12 R. E. Bailey EC372 Economics of Bond and Derivatives Markets Exercise 3: Futures Markets: II Speculation and Hedging 1. A company seeks to reduce the price risk associated with acquiring 1,000 barrels of oil ten months from the present. Describe how futures contracts could be used to achieve the com- pany’s goal. Explain why it is generally impossible to eliminate the price risk entirely. 2. ‘Hedging strategies are merely the consequence of optimal portfolio selection and, as such, cannot be distinguished from speculation.’ Discuss. 3. Outline the circumstances under which ‘normal backwardation’ is likely to prevail. What are the difficulties involved in testing the theory of normal backwardation? 4. Market Manipulation: cornering the market.
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Unformatted text preview: The notorious case of the Hunt brothers’ silver corner (1979/80) involved the Hunt brothers holding (i) dominant long positions (probably 60% or more of the open interest) in futures contracts for silver and (ii) large stocks of silver bullion and coin. (a) Explain why the Hunts’ strategy could be regarded as conspiratorial. How would they have benefited from it? (b) Using this example, what would you understand to be the main features, in general, of ‘cornering the market’. (c) What evidence should be required to justify the allegation of cornering the market? (d) Are there any natural forces (i.e. over and above legal action and regulatory control) which tend to limit the significance of market corners? *****...
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