ECON 315 Money and Banking

Published : 19-Oct,2021 | Views : 10

Question

A dental firm has estimated its demand for silver to be 10,000 troy ounces during December and January. The firm is concerned that prices will rise in the interim and would like to lock in today's price of $5.60 without purchasing the silver today. On June 15th, the CBOT's December futures contract trades at $5.90. Since each contract controls 1000 troy ounces, the firm locks into a price of $5.90 by buying 10 contracts. In late November, the spot price has increased to $8.00 and the futures contract is priced at $8.45. At that time the firm sells the futures contract and purchases the silver at spot prices. Compare the cost of purchasing silver in November, unhedged position, with cost of silver utilizing a hedging strategy.

Answer

Comparing the cost of purchasing silver in November, unhedged and hedge position:

Unhedged position	Value
Requirement	10,000
Spot price in November	$ 8
Cost of purchasing silver in November	$ 80,000

Hedged position	Quantity	Value	Amount
Buying futures	10	$ 5.90	$ 59,000
Selling futures	10	$ 8.45	$ 84,500
Profit			$ 25,500
Cost of purchasing silver in November	10	$ 8.00	$ 80,000
Net cost of purchasing Silver			$ 54,500

From the evaluation of the above table relevant cost position of hedged and unhedged silver could be detected. The hedged silver will mainly cost $54,000, while the unhedged silver will cost $80,000. The long hedging position has mainly reduced the relevant costing of silver, as the prices goes up, which could help in fixing the relevant vest of solver the level of $5.45. The basis of $0.30 witnessed in futures and spot price during November mainly allowed to create a spread of $0.45, which further reduced the costing of silver from $5.90 to $5.45. The companies with the help of hedging process are mainly able to reduce the risk from volatile prices and fix the cost of raw materials.

Reference and Bibliography:

Di Clemente, Annalisa, "Hedge Accounting And Risk Management: An Advanced Prospective Model For Testing Hedge Effectiveness" (2015) 44(1) Economic Notes

Wang, Ying and Jing Zhao, "Hedge Funds And Corporate Innovation" (2015) 44(2) Financial Management

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