Explain the concept of cross-hedging and the basis risk that results from cross-hedging.

CASE 2: FUEL HEDGING AT JETBLUE AIRWAYS

Traditionally, airlines cross-hedge their jet fuel price risk using derivatives contract on other oil products such as WTI and Brent crude oil. Consequently, an airline is exposed to basis risk due to asset mismatch. Please use the case “2012Fuel Hedging at JetBlue Airways” (available for download from Moodle) and your extra research to answer the following questions.

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(i)Should JetBlue Airways hedge its fuel price risk? Compare and contrast JetBlue’s approach to managing its fuel price risk to other US airlines. (ii)Given the high price of jet fuel at the end of 2011, should JetBlue hedge its fuel costs for 2012? And, if so, should it increase or decrease the percentage hedged for 2012? (iii)Explain the concept of cross-hedging and the basis risk that results from cross-hedging. Should JetBlue continue using WTI as an oil benchmark for its crude oil hedges or switch to Brent? Justify your answer using the provided data.

(iv)What alternative Risk Management techniques could JetBlue Airways have used?(v)What risks are being hedged, and what risks are left unhedged?

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