MGRM suffered a significant decline in oil prices, which led to massive unrealized losses and subsequent margin calls. The company used short-term futures to hedge its position due to a lack of alternatives, as the long-term futures contracts available were highly illiquid. MGRM’s open interest in unleaded gasoline contracts was 55 million barrels in the fall of 1993, compared to an average trading volume of 15–30 million barrels per day. The company encountered problems in the timing of cash flows required to maintain the hedge. Over the entire life of the hedge, these cash flows would have canceled out. However, MGRM’s problem was a lack of necessary funds needed to maintain its position. The fundamental issue manifested in the form of inadequate funds to mark positions to market and meet margin requirements. This situation was exacerbated by the significant decline in oil prices, which led to huge unrealized losses and subsequent margin calls, ultimately resulting in a loss of over $1.5 billion.

Choice A is incorrect because although MGRM did adopt a dynamic hedging strategy, it was not outdated or largely ineffective. The strategy involved using short-term futures to hedge due to a lack of alternatives, as the long-term futures contracts available were highly illiquid. The problem was not with the strategy itself, but with the company’s inability to predict the significant drop in oil prices and manage the associated funding liquidity risk.