Suppose the oil forward prices for 1 year, 2 years, and 3 years are $20,...
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Suppose the oil forward prices for 1 year, 2 years, and 3 years are $20, $21, and $22. The continuously compounded annualized 1-year effective annual interest rate is 6.0%, the 2-year interest rate is 6.5%, and the 3-year interest rate is 7.0%.
a) Consider the 3-year swap contract and suppose a dealer is paying the fixed price and receiving the floating oil price. What position in oil forward contract will hedge oil price risk in this position? Verify that the present value of the locked-in net cash flow is zero.
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