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Question - Booster Oil Co. is expected to produce 50 million barrels of oil in June for sale at the indexed-based spot price. Its management however resolved later on to hedge 50% of its expected June production at a fixed price of $60.00 per barrel with Smooth Oils in a SWAP contract (which is their best choice under the over-the-counter transactions presently). Management being aware of the opportunity costs involved as well as the benefits to be accrued were keen on considering the following assumptions for due diligence.
i) Assuming the index price of oil is $90 per barrel at the time specified for valuation in the contract, calculate the financial obligations/gain and comment on the results.
ii) Assuming the index price of oil is $40.00 per barrel at the time specified for valuation in the contract, calculate the financial obligations/gain and comment on the results.
iii) Explain the opportunity costs involved as well as the benefits to be accrued that management considered given the scenario above.
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