Question

It is February 2018. A manufacturer of jewelry must purchase 5,000 ounces of silver in July 2018 so that it can meet production requirements for existing Christmas inventory orders from various retailers. However, the firm’s managers are concerned that recent market volatility may lead to a spike in precious metals prices before July. The managers decide to hedge the firm’s exposure using the September 2018 silver futures contract. They purchase one contract on February 6 when the futures price is $16.905 per troy ounce.

In late July the firm closes out the hedge and purchases the required silver in the spot market. At that time, the basis is $.35 per troy ounce. What is the firm’s total hedged cost of the 5,000 troy ounces of silver?

Answer 1

Basis is defined as the variation between the spot price of a deliverable commodity and the relative price of the futures contract for the same actual that has shortest duration until maturity.

So in case of futures the hedged cost is anything which is lost profits from being on the wrong side of futures contract.

So the firms total cost is = 0.35*5000

                                         = $1750