Financial Risk Manager Part 1

The correct answer is A. Stack-and-roll.

Explanation:

Metallgesellschaft Refining and Marketing (MGRM) used a stack-and-roll hedging strategy to hedge their long-term forward contracts for oil delivery. Here's why:

• Stack-and-roll strategy: MGRM sold long-term forward contracts (up to 10 years) to supply oil at fixed prices. To hedge these positions, they used short-term futures contracts (typically 1-3 months) and "rolled" them forward as they expired. This created a mismatch between the long-term forward exposure and short-term futures hedging.

• Why not other options:

  • Delta hedging (B): While delta hedging is a common dynamic hedging strategy, it's typically used for options positions, not the specific strategy employed by MGRM.
  • Stop-loss strategy (C): This involves setting predetermined exit points for positions, which wasn't the primary hedging approach used.
  • Dynamic delta-hedging (D): This is a more general term for continuously adjusting hedge ratios, but doesn't specifically describe the stack-and-roll approach.

Key Risk: The stack-and-roll strategy exposed MGRM to significant basis risk and rollover risk, particularly when the oil market shifted from backwardation to contango, leading to substantial losses during the rollover of their short-term futures positions.