For problems 1 to 4, consider two firms, XYZ and Teleco. Firm XYZ mines copper, with fixed costs of $0.50/lb and variable costs of $0.40/lb. Teleco sells the telecommunications equipment and uses copper wire as an input. Suppose Teleco earns a fixed revenue of $6.20 for each unit of wire it uses. The wire price is the price of copper/lb plus $5. The 1-year forward price of copper is $1/lb. The 1-year interest rate is 6%. The 1-year option prices for copper are

C(0.9500) = 0.0649, C(0.9750) = 0.0500, C(1.0000) = 0.0376, C(1.0250) = 0.0274, C(1.0500) = 0.0194,

P(0.9500) = 0.0178, P(0.9750) = 0.0265, P(1.0000) = 0.0376, P(1.0250) = 0.0509, P(1.0500) = 0.0665

1. Suppose XYZ buys a put option with a strike of $0.95, $1.00, or $1.05. Draw a graph of the hedged profit in each case.

2. Suppose XYZ buys collars with the following strikes. Draw a graph of the hedged profit in each case. a. $0.95 for the put and $1.00 for the call b. $0.975 for the put and $1.025 for the call c. $1.05 for the put and $1.05 for the call

3. If Teleco does nothing to mange copper price risk, what is its profit 1 year from now, per pound of copper that it buys? If it hedges the price of wire by buying copper forward, what is its estimated profit 1 year from now? Construct graphs illustrating both unhedged and hedged profit.

4. Compute estimated profit in 1 year if Teleco buys a call option with a strike of $0.95, $1.00, or $1.05. Draw a graph of profit in each case.