This short case could be handed out at the end of class discussion on "J&L Railroad" [UV0251] in preparation for the following class, or if students are more experienced with hedging and option pricing, the instructor may choose to cover both cases in a single class period. It is the companion case to "J&L Railroad" [UV0251], and presents more technical issues regarding the hedging problem by requiring students to understand option-pricing principles. The board likes the CFO's hedging recommendations, but it wants a more careful analysis of the bank's prices for its risk-management products: the caps and floors. Besides demanding an understanding of option pricing, this case puts particular emphasis on the calculation and use of implied volatility.

Because of the regulatory environment in the railroad industry, J&L Railroad's profitability is dependent upon the price of diesel fuel. In this case, the student must decide how much of next year's expected fuel demand should be hedged and how it should be hedged. Hedging alternatives include exchange-traded futures and options as well as commodity swaps, collars, and corridors offered by Continental Bank's Risk Management Group.