Pinder Ltd is a company specialising in the brewing of a style of beer called IPA. A key ingredient in IPA is a type of hops called Simcoe Hops. Simcoe Hops is currently traded in the market for $20 per kilo.

It is July 2019 and you have been engaged by Pinder Ltd to provide them with advice on how they might manage their exposure to the cost of hops when they next need to buy them in November 2019.

The Chief Financial Officer (CFO) of Pinder Ltd tells you that hops prices are notoriously volatile (see here for example: goo.gl/3Muuvd) and she would like to understand how the use of options might assist her company in managing that risk.

1. Advise the CFO what style of option Pinder Ltd should consider purchasing (i.e. a put or call) and why that is the case.
2. Show using a payoff diagram the payoffs from the style of option selected in part (a) assuming that that option had an exercise price of $22 per kilo. Also include the payoff from an unhedged position (no need to use Excel here just label turning points and intercepts (if any)).
3. Now show using a profit diagram the cash flows for Pinder Ltd in terms of the cost they face in September (per kilo) for their hops if they hedge using the option described in (a) and (b). [assume that they pay $1 for the option]
4. Explain the circumstances if any under which Pinder Ltd will be worse off (overall) if they hedge using the options described above as compared with not hedging at all. Demonstrate this graphically.