Chartered Financial Analyst Level 2

Explanation

An airline hedging against rising fuel prices would most appropriately use an Excess Return Swap:

Why Excess Return Swap is appropriate:

• Airlines are primarily concerned with price changes in fuel costs
• They want to hedge against rising prices specifically
• Excess return swaps provide exposure to price appreciation/depreciation only
• They don't include collateral returns or other components

How it works:

• The airline would receive the excess return (price change) of the fuel commodity
• If fuel prices rise, the swap pays the airline to offset their higher costs
• This directly addresses their price risk exposure

Other options:

• Basis swap: For hedging basis risk between different commodities
• Total return swap: Includes collateral returns, which airlines don't need for pure price hedging

Therefore, C: an excess return swap is most appropriate for hedging rising fuel prices.