Question 11-3 THE LOGIC OF HEDGING WITH OPTIONS Morrison Oil and Gas Company’s

| November 9, 2018

uestion 11-3THE LOGIC OF HEDGING WITH OPTIONS Morrison Oil and Gas Company’s (fromProblem 11-1) chief financial analyst is Samuel (Sam) Crawford. Sam completed hisanalysis, suggesting that the investment is indeed a good one for the company, andpresented it to the firm’s executive committee. The executive committee consists ofthe firm’s CEO, CFO, and COO. The CFO thought Sam’s analysis was on target, butthe COO and CEO were concerned about the fact that the hedging strategy would notwork for the investment. In fact, they wondered why hedging the investment is such agood idea. Sam thought for a second or two before responding and decided how tobest explain why the project is a good one and involves hedging the investment cashflows using one-year call options on natural gas. These call options, which have a$13.90-per-MCF strike price, are selling for $1.86 per MCF. Show how selling calloptions on 50 MCF of gas today and undertaking the investment provides Morrisonwith a hedged (i.e., risk-free) investment.Titman, Sheridan; Martin, John D. (2014-04-08). Valuation (2nd Edition) (Prentice Hall Series in Finance) (Page 423). Prentice Hall. Kindle Edition. Hi you did such a great job of answering my question last week I have another

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