Financial Risk Manager Part 1

Explanation

The Metallgesellschaft case is a classic example of a hedging strategy failure due to cash flow timing mismatches.

Key Points:

• Metallgesellschaft sold long-term fixed-price oil contracts to customers
• To hedge these positions, they used short-term futures contracts
• This created a mismatch between:
  • Long-term receivables (fixed price oil deliveries over time)
  • Short-term payables (frequent margin calls on futures positions)

Why Option D is Correct:

• When oil prices fell, Metallgesellschaft faced massive margin calls on their short futures positions
• However, they couldn't collect the corresponding gains from their long-term contracts immediately
• This cash flow timing difference created a liquidity crisis that forced them to unwind positions at a loss

Why Other Options are Incorrect:

• A: While German accounting rules may have influenced reporting, they weren't the primary cause
• B: There was no evidence of outright fraud in the case
• C: Computer systems weren't identified as a major contributing factor

The case demonstrates the critical importance of considering cash flow timing and liquidity risk in hedging strategies, especially when using short-term instruments to hedge long-term exposures.