THE SUITABILITY OF CROSS-HEDGING POLYMERS WITH BRENT FUTURES CONTRACTS
Date
2011-11-03
Authors
Masitwe, April
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Abstract
This research report investigated the effectiveness of cross-hedging polymers with brent futures contracts for manufacturers of plastic commodity products. The purpose was to find out whether volatile polymer raw material prices could, through this method, be stabilised to create predictable input costs for manufacturers. Global polymers from South East Asia, United States Gulf, North West Europe and South Africa were studied. Each were correlated and the polymer with the best correlation level was selected and cross-hedged through a simulation model to determine how effectively volatilities could be reduced.
The results showed that correlations were inconsistent for all polymers. They varied from period to period and from region to region. Correlations (r ) ranged from 0.25 to 0.87. The polymers were found to have a time lag of zero to eight weeks with the brent futures price movements. LDPE, which showed the longest lag period, was found to have unreliable correlation with brent futures. HDPE Injection grade US Gulf, which had the best correlation at 0.87, was cross-hedged. The hedge was found to be ineffective, in that it exposed the manufacturer to more volatile input cost. It was also found to add a second excessively high risk exposure from the margin account that the manufacturer had to maintain in the futures exchange.
It was concluded that manufacturers were more cost-effective using an internally managed standby fund to absorb polymer input price because of lesser exposure to risk. However, it could not be guaranteed that the standby option would always be more cost effective
Description
MBA thesis - WBS
Keywords
Hedge funds, Polymers, Brent futures