Suppose that you are a silver fabricator. You will acquire 2,000,000 troy ounces

Question

Suppose that you are a silver fabricator. You will acquire 2,000,000 troy ounces of silver at the prevailing market price on July 15, 2016, from your long-time business partner. But, you worry about the uncertainty in the market price of silver in the future. Hence, you decide to use Globex (“online”) silver future contracts to hedge risk. You will place an order of silver future contracts at the last day closing price of the date when you enter into the futures contracts at the last day closing price of the date when you enter into the future contracts.

1. Which type of hedge, between short and long, has to be used?

2. What is the contract size of the silver futures per one contract? How many contracts do you have to trade?

3. State the date you enter into the silver futures contract and future price (last closing price) that you determined. Attach the snapshot of the price listing. See an example.

4. Assume that both the spot and future prices in July 15,2016 are $11 per ounce. Find out profits of the unhedged spot position, future position and hedged position (hedged position = unhedged spot position + future position)

5. Assume that both the spot and future prices in July 15 are $16 per ounce. Find out profits of the unhedged spot position, future position and hedged position.

6. Discuss the effectiveness of your hedged.

7. Now, suppose that you don’t have to acquire 2,000,000 ounces of silver from your business partner at the spot market in September. You will directly use the silver future market to acquire silver and to hedge price risk. Determine the cost to acquire silver and to hedge price risk. Determine the cost to acquire silver of 2,000,000 ounces. Explain this hedge and compare with the hedged in (1) ~ (5).

Please show step by step

Explanation / Answer

1)

Since, I own silver I wish to hedge against short future contacts to compensate against loss.

2)

The contract size of silver futures would be 5,000 troy ounces.

The number of contracts to be traded are 2,000,000/5,000., 400 contracts.

3)

The date of entering contract is 15th July, 2016.

4)

Particulars

Hedge

Unhedged

Spot price on date of entering

11

11

Contracted rice

16

16

Profit/loss

5

-5

Particulars

Hedge

Unhedged

Spot price on date of entering

11

11

Contracted rice

16

16

Profit/loss

5

-5

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