The CFO at Brosnan, Inc., a book publisher, is concerned about the rising prices of paper and ink. She is considering the use of derivatives to lock in today's prices.

Required:

1. One strategy used by Brosnan, Inc., is to buy pulp-paper futures on commodities exchanges. Paper prices can go up and down by more than 10% in a short period. When paper prices increase, Brosnan's operating profits fall. Explain how pulp-paper futures can be used to protect Brosnan's profits from harmful paper price increases.

2. How will the pulp-paper futures affect profits if paper prices instead decline?

3. Ink prices tend to be even more volatile than paper prices but cannot be hedged by exchange-traded futures. So, the CFO asked an ink supplier to set up a forward contract for about half of the amount purchased each year. Explain how a forward contract can be used to protect Brosnan's profits from harmful ink price increases.

4. How will the forward contract affect profits if ink prices instead decline?