You manage your family’s jewelry manufacturing business. You will begin producin

Question

You manage your family’s jewelry manufacturing business. You will begin producing product for the 2009 holiday season beginning in June. You estimate that you will need 2,000 ounces of gold. Gold is currently selling at $925/oz. You would like to lock in this price. Gold futures contracts for June delivery are 100 oz. each, and are currently selling for $930/oz.

Structure a hedge using gold futures contracts that will (approximately) lock in an average price of $925/oz for the required gold.
(a)Will you go long or short futures?
(b)How many contracts will you use?

On June 1, the price of gold is $840/oz.
(a) What is your gain/loss on your futures position?
(b) What is your gain/loss on your combined position?

Explanation / Answer

a)
buy gold spot at $925/oz and hedge it by going short in future at $930/oz.So, by june if spot prices do not exceed $935/oz, there will not be any loss. Above this price,loss will be minimized by $5/oz. (ANSWER)
b)

No. of contracts = Qty/contract size = 2000/100 = 20 (ANSWER)

c)

Gain in future contract = 930 - 840 =$ 90/oz i.e. total gain 90*2000 = $180000 (ANSWER)

d)

Gain on combined position =gain in future - loss on spot deal

= 180000 - (925 - 840)*2000 = 180000 - 170000 = $ 10000 (ANSWER)

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