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Basis RiskAs discussed, Metallgesellschaft AG make use of the stack and roll hedge schema. This strategy brought about prat risk, the risk of no direct relationship between movements in the futures merchandise and movements in the longer maturity contract.What Went Wrong?In 1993, oil prices began to soak up because of a bearish market place signal. The value of the futures purchased decreased drastically and the market reversed from backwardation to contango. From Backwardation to ContangoA nonher issue, which abstruseed MGs problems, was the shift of the oil market from normal backwardation to contango. Refer to Figure I for a fail find outing of these concepts. In normal backwardation, the strategy worked fine, however the contango market created losses that were unrecoverable and the longer the market stayed in contango, the losses continued to get together on the rollover. Had the market stayed in normal backwardation, MGRM hedgerow strategy would pay off been highl y profitable, making a gain on all rollovers. MGRMs main undoing was that the rollover loss was unrecoverable and not offset by another position. Although the contango market was not the only cause for MGRM problems, it did help to compound the cash flow crunch of the company. The main people responsible of such losses will be discussed later.The Companys advisor, Deutsche marge, convinced Metallgesellschaft AG to close all positions, taking $1.5 billion in losses, with the aim to keep back additional losses. As can be seen from the Figure II below, Deutsche Bank should have been calmer as the market rebounded with oil prices starting to soar in 1994, an sum up of about $8 dollars per barrel in few months. This increase would have highly benefited the MGRM... ...vernanceMetallgesellschaft AG should have ensured that the parent companys traders and MGRMs employees worked on behalf of the shareholders interests. Instead of undertaking a reasonable hedging strategy, Metallgesellsc haft AG traders were motivated by big bonuses opportunities, resulting in a more(prenominal) reckless speculative strategy and as a result maturation the company into a financial intermediary. Their users, such as employees, creditors, and supervisors, had to fully understand the purpose of the hedging strategy. This was highly important since the hedging program should not be separable from the business strategy.ConclusionTo conclude, the main motive of the losses sustained was the minimal study made on the hedging strategy before adoption. Metallgesellschaft AG should have thoroughly analysed the market before entree into such a big hedging program.