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Hedging strategy to protect against falling prices Price fluctuations in commodities can have significant consequences for companies, especially if the fluctuation involves a prime raw
Hedging strategy to protect against falling prices Price fluctuations in commodities can have significant consequences for companies, especially if the fluctuation involves a prime raw material for a company. Different companies will adopt different strategles to manage the risk in price fluctuations, including adjusting the timing of their commodi purchases, maintaining a safety stock of their raw materials, and hedging. The company's cost of producing copper is about $3.95 per pound. The current market price for copper is $4.74 per pound. The six-month futures price for copper is $4.94 per pound. At this selling price, the company can maintain its earnings growth. The company expects to produce 750,000 pounds of copper in this six months. (Note: Copper futures are traded at a standard size of 250,000 pounds.) If the company does not hedge the copper it produces, it can expect to earn a total revenue of at the end of six months. If Hungry Whale places a hedge on its copper production in the futures market, it would contracts for delivery in six months at a delivery price of $4.94 per pound to generate profits thot maintain its desired earnings growth. When the contract comes due in six months, the spot price of copper is $3.36 per pound in the cash markets. Prices on the new six-menth futures contracts in copper are $4.20 per pound. Calculate the expected revenue in the following markets: Futures Market Net gain or loss in the futures market. - $442,500 S1. 195.000 Calculate the expected revenue in the following markets. Futures Market Net gain or loss in the futures market: $442,500$1,185,000$3,150,000$3,705,000 Cash Market Net gain of loss in the cash market: $555,000$442,500$3,150,000$300,000 The cost of production of copper is $2,962,500. Thus, Hungry Whale wuir in the futures market and in the cash market. This gain and loss offset each othec, and the compony benefits trom placing the hedge, This hedging strategy woild be referred to as a The cost of production of copper is $2,962,500. Thus, Hungry Whale will in the futures market and in the cash market. This gaie and loss offset each othet, and the compony benefits from placing the hedge. This hedging. strategy would be referred to as a hedge, and it helos protect the producer to sell a commodity against falling prices
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