AB Cable, Wire, and Fiber plans to open up a new factory three years from now, at which point it plans to purchase 1 million pounds of copper.

Assume zero-coupon risk-free yields are going to remain at a constant 5 percent (annually compounded rate) for all investment horizons, there is no basis risk in forwards or futures, storage of copper is costless, markets are frictionless, and forward spot parity holds. Copper has a 3 percent per year (annual compounded rate)

convenience yield.

a. What should the relative magnitude of the futures and forward prices for copper be, assuming the contracts are of the same maturity? How should futures and forward prices change with contract maturity?

b. Assume that one-year forwards are the only hedging instruments available. How many pounds of copper in forwards should be acquired today to maximally hedge the risk of the copper purchase three years from now?

How does the hedge ratio change over time?

Provide intuition and describe the rollover strategy at the forward maturity date.

c. Assume that three-month futures are the only hedging instruments available. How many pounds of copper in futures can be acquired today to maximally hedge the risk of the copper purchase three years from now? How does the hedge ratio change over time? Provide intuition and describe the rollover strategy at the futures maturity date.

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